






.0* V" * V <V 



<♦*.•;*&% 6**.aSit. o /^Ja&X 




^ 



S>..*^'\o> ^* 




*► 



*** 




















• 1 1 






























> ^ '-«^ ^°* 

\%$*y \jW^ '°\^\/ °\* 







0* <k *7??fi * a 




o* .•••. *e 



"oV 



V^V V^> v^V V-- 







^v^\ ^.^fe.% **&&:% .**,.; 



4 



r *> 



4 o 



»°-V 



\° .^ 



5^ 



LOANS AND INVESTMENTS 

CONTRIBUTORS 



O, M. W. SPRAGUE 

Professor of Banking and Finance in Harvard University 

E. W. KEMMERER 

Professor of Banking and Economics in Princeton University 

H. PARKER WILLIS 

Secretary Federal Reserve Board 

THOMAS B, PATON 

General Counsel American Bankers Association 

HAROLD J. DREHER 

Assistant Cashier National City Bank of New York 

C. W. ALLENDOERFER 

Assistant Cashier First National Bank of Kansas City 

GEORGE E. ALLEN 

Educational Director American Institute of Banking Section 
American Bankers Association 



Messrs-. Sprague, Kemmsrer, Dreher. Allendoerfer and 
Allen are members of the Institute Board of Regents 



American Institute of Banking 

Section American Bankers Association 
Five Nassau Street New York City 






Copyright 1916 

By 

American Institute of Banking 




DEC -8 1916 
©CI.A445996 



CONTENTS 



Chapter Page 

I. Commercial Loans 5 

II. Agricultural Loans „ 51 

III. Stocks and Bonds 97 

IV. Collateral Loans 137 

V. Seasonal Demands for Money. 177 

VI. International Exchange 216 

VII. Bonds and Circulating Notes 255 



LOANS AND INVESTMENTS 



CHAPTER I 
Commercial Loans 

BANKS are commonly thought of as being 
chiefly engaged in the business of lending 
money, but at a matter of fact money loans 
make up a small part of their business. The invest- 
ments of savings banks are indeed limited to the 
funds which they have received from depositors, 
together with such amounts as have been set aside 
from profits as surplus, and also in the case of 
stock savings banks the amount received from 
subscriptions to capital stock. Other banks, includ- 
ing the banking departments of trust companies, 
while they must always be prepared to furnish 
money on demand, do not limit their loans and 
other investments to the funds received from de- 
positors and shareholders. They lend their credit 
as well, and thus create a large part of the funds 
utilized by borrowers. Banks other than savings 
banks might well therefore be called credit banks. 
Unfortunately a somewhat less descriptive term is 
in common use— Commercial Banks. 

2. BANK NOTES AND CHECKS. — Com- 
mercial banks are able to lend their own credit and 
thus manufacture a large part of the funds which 

5 



6 LOANS AND INVESTMENTS 

they furnish borrowers, because they provide a 
more or less generally acceptable substitute for 
coined money as a circulating or purchasing 
medium. The bank note, the promise of a bank 
to pay money on demand, is quite obviously a 
credit instrument which is a substitute for money; 
and in the absence of legal restrictions upon issue 
the volume of such notes in circulation would 
clearly depend upon the willingness of people to 
accept them in payment for goods and services. 
Partly because of legislation limiting the power to 
issue notes, and even more because the check has 
been found more convenient for most purposes, 
the bank note has become a subordinate and 
rather special means of extending credit. Banks, 
of course, do not extend credit directly by issuing 
checks, since the check is an order on a bank to 
pay money, not a bank's promise to pay money. 
Such orders are based upon obligations to pay 
money recorded on the books of the bank, known 
as deposits. This term deposits is a misnomer. 
It suggests to most people that the bank has at 
some time or other received from depositors the 
amount of their deposits in money. Banks are 
often spoken of as lending their deposits. This 
is a most inaccurate and misleading use of lan- 
guage, since deposits are obligations already in- 
curred, an existing liability, which, moreover, is 
largely due to loans granted. Clearly a bank can- 
not lend its already existing obligations to pay 



LOANS AND INVESTMENTS 7 

money on demand. It may indeed happen that a 
bank receives, let us say, $1,000 in money from a 
depositor, and is on that account in position to 
lend more than might otherwise have been advis- 
able. But even here it is not the deposit which 
it lends, but either the $1,000, or, and this is far 
more likely, a new right to draw $1,000. Both 
transactions, the receipt of the $1,000 and the loan 
of $1,000, will then have created absolutely similar 
deposit obligations. 

3. LOANS AND DEPOSITS.— It is the gen- 
eral use of the check that makes it possible for 
banks to create deposits through their lending 
operations. If borrowers made all payments with 
money it would be necessary for them to withdraw 
the proceeds of their loans from the banks in the 
form of money. The business of commercial banks, 
like that of savings banks, would then be limited 
to the funds secured from depositors and share- 
holders, and possibly some slight amounts in 
addition thereto, since borrowers would presum- 
ably not immediately draw out the entire proceeds 
of their loans. It may, however, be objected that 
even though the borrower does use checks the bank 
will be obliged to make payment almost as speedily 
as if money was used. Checks do not circulate 
indefinitely; they are quickly presented for pay- 
ment over the counter or by other banks in which 
they have been deposited. Assuming that a bank 
were abruptly to double its deposit obligations by 



8 LOANS AND INVESTMENTS 

granting many new loans, it would be confronted 
almost at once with heavy demands for payment 
on account of the largely increased number of 
checks that would certainly be drawn upon it. 
Objections of this sort are frequently raised against 
the possibility of the creation of deposits by banks 
in excess of the momentarily unused proceeds of 
their loans. If it is a question of the possibility 
of extending credit by a single bank, such objec- 
tions are valid. A bank which should suddenly 
increase its deposit obligations would begin to lose 
cash almost at once because more checks would be 
drawn, and most of them would be deposited in 
other banks, thus occasioning a succession of un- 
favorable balances against it. If, however, all the 
banks of a locality increase their loans, with a con- 
sequent expansion of deposits, to something like 
the same extent relative to the scale of their past 
obligations, each bank will have a greater number 
of checks drawn upon it, but will also receive from 
its depositors a greater number of checks drawn 
on the other banks. There will be a greater num- 
ber of checks drawn but not a correspondingly 
greater amount of cash needed in making settle- 
ments between the banks. This increase of accom- 
modation to borrowers by the banks of a single 
locality would probably lead to increased pur- 
chases from producers elsewhere, thus occasioning 
a balance of indebtedness against the local banks. 
Sooner or later currency would have to be shipped 



LOANS AND INVESTMENTS 9 

to banks in other parts of the country, and this 
would put a check on further expansion, and might 
make contraction necessary. But again if expan- 
sion of bank loans were countrywide this difficulty 
would not be experienced, except from the possi- 
bility that gold exports might be stimulated, and 
even this contingency would not present itself if 
the expansion of credit were worldwide. Finally 
it should be observed that even when the expansion 
of deposits and the increased drawing of checks are 
confined to a few banks they cause merely a shift- 
ing of cash among the banks; it does not diminish 
the cash foundation of the credit structure. 

4. CASH AND CREDIT.— The conclusions 
regarding deposits outlined above rest for their 
validity upon the assumption that the checks used 
by depositors in making payments are generally 
received by persons who deposit them to the credit 
of their own accounts. This is very largely true, 
at least in English speaking countries, in which 
something like 90% of payments seem to be made 
with checks. For wages and for a variety of mis- 
cellaneous payments money or bank notes are 
required; but certainly an overwhelmingly large 
proportion of payments made with the proceeds of 
bank loans are made to persons who have bank 
accounts, so that the entire subsequent series of 
operations is made without the use of money, aside 
from the shifting of cash among the banks them- 
selves. But while the creation of deposits by the 



10 LOANS AND INVESTMENTS 

making of bank loans does not involve an equiva- 
lent outflow of money from the banks, there is a 
direct connection between the cash holdings of the 
banks and their power to extend credit. Confidence 
in the banks is the foundation on which rests the 
structure of bank credit, and one important factor 
in establishing and maintaining confidence is the 
cash reserve. Whether this store of money is 
largely held in a single central institution, as in most 
European countries, or widely scattered among 
many banks, as in the United States, in every 
instance we find that some more or less definite 
relation of money to deposit liability is regarded 
both by bankers and the public as a necessary safe- 
guard for the structure of credit. In the United 
States a minimum ratio of reserve to deposits, 
at first regarded as advisable, was later imposed 
upon the banks by law. In no other country are 
banks subject to similar restriction upon their 
operations. Some legislation on this matter was 
doubtless necessary, because in the absence of 
branch banking, also generally prevented by law, 
business is conducted in this country by many 
thousands of banks, large and small, many of which, 
as our early history made evident, were certain to 
work upon utterly inadequate reserves. This legal 
remedy, however necessary, has had some unfor- 
tunate consequences. A rigid requirement of an 
irreducible reserve ratio deprives the banking 
system of all elasticity beyond a certain point in 



LOANS AND INVESTMENTS 11 

the granting of deposit credits. It has tended also 
to foster in the public mind an exaggerated idea 
of the importance of this one, and by no means the 
most important, element of banking strength. As 
a consequence, the maintenance of the reserve has 
exerted an enormous influence in shaping banking 
practice, especially in the distribution of bank 
resources among the various classes of loans. This 
insistent attention given to the maintenance of 
reserves would have comparatively little effect 
upon the lending operations of the banks, if changes 
in cash holdings were small and also predictable; 
but for the ordinary bank this is far from being 
the case. However universal the use of checks 
may be, the individual bank continues to be subject 
to variations in the demands upon it for cash. A 
bank can exert no control over the use its depositors 
make of their accounts from day to day; checks 
deposited with it never exactly balance checks pre- 
sented for payment. There will be wide variations, 
sometimes favorable, sometimes unfavorable. In 
the latter contingency reliance may be placed upon 
a speedy change in favor of the bank, especially 
if this may be presumed with some certainty from 
knowledge of the customary action of impor- 
tant accounts. More positive action designed to 
strengthen its cash holdings, however, is certain 
to become necessary from time to time in the ex- 
perience of every bank. The requirements of 
depositors will occasionally result in a succession 



12 LOANS AND INVESTMENTS 

of unfavorable balances; and further, every bank 
must face the possibility that unfounded rumors 
may subject it to a run. It is imperative, therefore, 
that a bank be able to pay out large amounts of 
money on demand and also be in position quickly 
to replenish depleted reserves. Its assets, or at 
least a considerable portion of them, must be of 
such a character that they can be quickly converted 
into money. 

5. ASSETS MUST BE LIQUID.— Liquidness 
of assets enables a bank to meet the actual needs of 
its depositors for money and also by giving con- 
fidence serves to limit withdrawals to actual needs. 
This is with most people, and properly should be, 
the fundamental basis for confidence in a bank. To 
serve the purposes just mentioned the same degree 
of liquidness in all assets is not required. Imme- 
diate convertibility into cash of a portion of the 
assets of a bank is sufficient for the building up of 
reserves depleted on account of unusually large re- 
quirements on the part of depositors, or even for the 
exceptional contingency of a run upon the bank. 
Experience shows that a bank all of whose assets 
can be converted into cash within a few months 
without loss is altogether unlikely to be disturbed 
by lack of confidence, and should it be subjected 
to unfounded rumors no difficulty is experienced in 
securing the necessary funds from other banks. 

6. LINES OF CREDIT.— The investments 
which best meet the peculiar requirements of com- 



LOANS AND INVESTMENTS 13 

mercial banks are loans payable either on demand 
or within a few months, seldom more than six 
months. With a reasonably large number of short 
time loans, so selected that some of them will be 
maturing daily or at least nearly every day, and all 
of them within a six months period, it might seem 
at first sight that if a bank adopted the simple means 
of refraining from making new loans, the payment 
of these loans would automatically provide a bank 
with funds to meet all ordinary requirements. But 
the problem which confronts the banker is not of 
this simple character, because there are other con- 
siderations which must be given weight in handling 
the loan account of a bank. If a bank is to continue 
as a going concern engaged in profitable business it 
cannot entirely discontinue the making of loans. It 
holds its business depositors largely through its 
readiness at all times to furnish them a reasonable 
amount of accommodation. Within limits of safety 
determined by the character of the depositor, the 
nature of his business, the size of his account and 
the size of the bank, lines of credit have been agreed 
upon. These agreements clearly place a part of the 
lending power and consequently a part of the assets 
of the bank outside the field of practical every day 
liquidness. For a bank regarded as a going concern, 
therefore, a considerable proportion of its resources 
are unavailable as a means of strengthening itself 
for the purpose of meeting ordinary requirements. 
Further, unless borrowers have in general already 



14 LOANS AND INVESTMENTS 

fully utilized their lines of credit, the bank is subject 
to the possibility of additional demands for accom- 
modation, which it cannot refuse to grant, and which 
may come just at a time when it is meeting un- 
usually heavy payments to depositors either directly 
or through unfavorable balances with other banks. 
Even in periods of acute monetary stringency it 
must be prepared to create new deposit liabilities by 
making new loans. Striking instances are found in 
the case of those banks which have accounts of stock 
brokers who ordinarily borrow on the market, or of 
business firms which place their paper with many 
banks through note brokers. It is a common prac- 
tice, and one dictated by sound business policy, for 
such borrowers not to borrow from their own banks. 
Lines of credit are kept open to fall back upon when, 
as may happen, it becomes difficult, if not impos- 
sible, to borrow in the open market. The borrower 
has thus an anchor to windward. But, on the other 
hand, banks that have such accounts have incur- 
red obligations to extend credit just when it may 
be most inconvenient for them to do so. 

7. LIQUIDNESS OF LOANS TO DEPOSI- 
TORS. — Clearly then a bank should have assets 
more liquid than its loans to its own clientele of 
business depositors. The conclusion should not be 
drawn, however, that the loans made to such regular 
customers need not possess the quality of liquidness. 
The analysis in the preceding paragraph was con- 
cerned altogether with these loans taken as a class. 



LOANS AND INVESTMENTS 15 

The individual loans within this class must be liquid 
to enable a bank to extricate itself from threatened 
failure or suspension, contingencies which would 
inconvenience borrowers far more than the refusal 
to allow them accommodation agreed upon under 
lines of credit. Moreover, there is another and even 
more important reason for insisting upon liquidness 
in the case of these loans. A large part of the loans 
made by banks is based upon personal security 
alone, promissory notes with or without indorse- 
ments. The underlying security rests very largely 
upon the uses made by the borrower of the proceeds 
of these loans. If the transaction in connection with 
which the proceeds of the loan are used will be com- 
pleted during its life the loan may be said to pay for 
itself. It is to be presumed also that borrowers will 
use the proceeds of loans which they are to repay 
in a few months more wisely than might be the case 
if the payment were indefinitely deferred. More- 
over, conclusions based upon the analysis of the 
statements of borrowers and upon other informa- 
tion are a basis for short time credit only, since over 
a long period conditions may change radically for 
the worse. Unsecured loans must therefore as a 
rule possess that quality of liquidness which comes 
from short maturities to make them a proper in- 
vestment for banks or indeed for any lender. One 
common method of seeking not only to make cer- 
tain that the loans made under lines of credit shall 
be liquid, but also to determine whether credit may 



16 LOANS AND INVESTMENTS 

be safely continued, is to insist that all borrowing be 
cleaned up at least once a year. This is often an 
effective requirement, though it may be more nomi- 
nal than real, since borrowers may simply allow 
accounts payable temporarily to pile up against 
them. The supply of credit which the banks are in 
position to lend is, however, so large that the banks 
quite generally do lend more or less continuously to 
many borrowers. Concerns whose business is 
growing and which show good earning power are a 
reasonably safe basis for such loans pending a time 
when they may be expected to secure additional 
capital by means of more permanent obligations, by 
an issue of additional capital stock, or by the grad- 
ual process of putting profits back into the business. 
Firms engaged in a few lines of business may per- 
haps be regarded as satisfactory borrowers even 
though they continue to rely indefinitely upon 
banks for a part of their working capital. In such 
cases it is essential that the firm shall be engaged 
in a business the products of which are in constant 
demand and therefore readily saleable for cash. 
8. COLLATERAL LOANS TO DEPOSI- 
TORS. — Based upon knowledge of the amount 
of loans made in former years, the future needs 
of regular commercial depositors can be fairly well 
determined ; but, as in the case of the requirements 
of depositors for cash, the estimate cannot be exact, 
and for short periods may be wholly at fault. Evi- 
dently, if it is regularly to keep its funds fully em- 



LOANS AND INVESTMENTS 17 

ployed, a bank must invest a part of them in other 
ways, in assets which can be converted into cash 
without disturbing valuable relationships. The 
banker may have made a considerable number of 
collateral loans to his depositors. The greater part 
of such are made on the security of stocks and 
bonds; and, leaving out of view those made to 
depositors who are engaged in the business of mar- 
keting securities, these loans can be allowed to 
mature and new loans can be refused with less 
danger of loss of accounts than in the case of regu- 
lar commercial borrowers. This is because the 
proceeds of collateral loans are largely used to 
enable borrowers to pay for purchases of securities 
and for other purposes outside their regular busi- 
ness. Moreover, the borrowers whose loans are 
based on readily marketable collateral, can arrange 
to borrow from other banks more readily than is 
generally true in the case of the commercial bor- 
rower. 

9. REDISCOUNTS. — Few if any banks are 
likely to have made these occasional loans to 
depositors to such an extent as to furnish them 
speedily through contraction with a considerable 
amount of funds. It is clearly necessary, therefore, 
that a bank invest a part of its resources outside of 
the circle of its own depositors, unless it is pre- 
pared to borrow frequently from other banks. For 
small banks, country banks and those in the small 
cities, this has always been quite feasible by means 



d * 



18 LOANS AND INVESTMENTS 

of loans from their city correspondents, but it is 
a kind of business which has not been very largely 
developed in this country. There has been a pre- 
judice against it among many bankers, who feel 
that it in some way reflects upon their credit. In 
a community in which local requirements are at 
certain seasons of the year decidedly greater than 
the resources of the local banks, it would seem to 
be a most desirable method of raising funds. 

10. BANK BALANCES AND BONDS.— Bal- 
ances with city banks in excess of the amount which 
can be counted as a part of the legal reserve are 
another means of providing funds to meet unusual 
needs. The rate of return on bankers' balances, 
customarily 2%, does not make this a very profit- 
able method of employing what may be called a 
bank's secondary reserve, except during periods of 
monetary ease when rates for loans are at a low 
level. Bonds which are readily saleable may serve 
this purpose also, but at no little risk of loss. In 
periods of business inactivity following a crisis, 
bonds are indeed a very satisfactory means of 
utilizing some portion of the resources of a bank. 
They can then usually be purchased at relatively 
low prices, and if disposed of at the beginning of 
a period of renewed business activity are likely 
to have appreciated in value. In periods of con- 
tinued activity, however, bonds are likely to fall 
somewhat in market price, and in periods of general 
strain may become almost unsaleable. Bonds in 



m 



LOANS AND INVESTMENTS 19 

general would seem to be satisfactory as a special 
investment to meet serious contingencies of par- 
ticular banks rather than as a resource in periods 
of general financial strain. If a bank is threatened 
by a run its holdings of bonds are apt to prove a 
more speedy means of securing funds from other 
banks than its ordinary loans to depositors. It may 
also be added that bonds are required as security 
for Government deposits and also in many States 
for State, county and municipal deposits. These 
requirements explain the large investment of many 
banks in bonds. 

11. COMMERCIAL PAPER.— There remain 
for consideration two additional profit earning 
resources which may be relied upon for quick con- 
version into cash. There are two classes of loans 
insistence on payment of which, together with the 
refusal to make new loans, does not subject a bank 
to the danger of the loss of any business advantage. 
These loans are commercial paper purchased from 
note brokers and collateral loans made to stock 
brokers and investment bankers who are not de- 
positors of the lending bank. Note brokers are 
resorted to by business concerns whose borrow- 
ings are large, often too large to be granted by 
one or more banks, even by those of the larg- 
est size. Banks purchasing this paper incur abso- 
lutely no obligation to take additional paper in 
the future. They may buy regularly or intermit- 
tently, as suits their own convenience ; the relation 



20 LOANS AND INVESTMENTS 

between borrower and lender is absolutely imper- 
sonal. Commercial paper purchased from note 
brokers has for many years been a favorite avenue 
for the employment of a considerable portion of 
the secondary reserve of the banks. A banker is 
indeed less likely to know intimately the character 
of this paper than that of loans made to his own 
depositors. Here, however, the note broker, if 
wisely selected, is a valuable safeguard. It may be 
said without qualification that the losses of banks 
from commercial paper purchased from note 
brokers of high standing have been far less than 
those from loans to their own depositors, and im- 
measurably less than those from purchases of paper 
from distant borrowers made directly in order to 
save the broker's commission. The notes which 
are sold to the banks by note brokers are generally 
in round amounts of $5,000 and in multiples of 
$5,000. Only very large banks will have sufficient 
funds invested in this way to provide them with a 
steady succession of maturities. For the small 
bank, therefore, commercial paper is rather a means 
of employing surplus funds which are not likely 
to be needed during the continuance of the loan. 
In this connection it should be noted that there 
seems to be a tendency to lengthen the average 
maturity of this class of loans, owing to the fact 
that the borrower ordinarily pays the same com- 
mission whether the paper is to run for three or 
for the maximum period of six months. This 



LOANS AND INVESTMENTS 21 

longer average maturity lessens the value of com- 
mercial paper to most banks as a liquid asset for 
ordinary working purposes. 

12. LOANS ON SECURITIES.— The favorite 
investment for funds which may be needed at any 
moment is the collateral loan to stock brokers and 
to banking houses engaged in marketing securities. 
A part of these loans is on time and has very much 
the same utility as a means o'f employing banking 
funds as commercial paper purchased from note 
brokers with the further advantage that a greater 
range of maturities is available. There is a broad 
market for collateral loans maturing all the way 
from one month to six months. A large part 
of the total of collateral loans also is payable on 
demand. Stock exchange dealings and the mar- 
keting of securities are unlike all other kindsi of 
business in that they can be in part conducted on 
the basis of call loans. The quick saleability of the 
commodity handled makes this possible; conse- 
quently, we have here a demand for loans under 
such conditions as to enable banks to make full use 
of their lending power right up to the limit set by 
their reserve requirements. In the absence of the 
call loan it would clearly be impossible for the 
banks to keep their reserves intact and at the same 
time lend close to the limit of reserve requirements. 
Many considerations must be taken into account 
in determining the relative amount of its funds 
which shall be employed by a bank in the various 



22 LOANS AND INVESTMENTS 

ways which have been outlined. Banks whose de- 
posits fluctuate with some degree of regularity can 
naturally invest in a different fashion from those 
subject to large requirements which cannot be 
foreseen. 

13. ADJUSTMENT OF RESERVES. — Let 
us now assume that a bank which has invested in 
all of the various ways above described finds itself 
below reserve requirements. From knowledge of 
the tendencies of the accounts of its depositors it 
may perhaps be reasonably certain that within a 
few days through deposits of cash or through de- 
posits of checks giving it a favorable balance with 
other banks its reserve will be restored. Many 
bankers in these circumstances might be content to 
allow affairs to take their own course. Others, 
especially in cities where the banks publish a weekly 
statement, would be likely to call some of their 
demand loans but might continue to purchase com- 
mercial paper and make time collateral loans to 
an amount something like current maturities of 
such loans. If, however, there was reason to be- 
lieve that depositors were likely still further to 
draw down their balances and if demands for 
further accommodation from depositors were to 
be expected, a much greater reduction in call loans 
might be made and at the same time new invest- 
ments in commercial paper, and in time collateral 
loans, might be largely discontinued. No one of 
these three kinds of loans would presumably be 



LOANS AND INVESTMENTS 23 

liquidated before a beginning was made with the 
other two. Some weight would of course be given 
to the relative rates prevailing for each of these 
three kinds of loans. Bonds would probably not 
be disposed of unless a pronounced change in the 
conditions surrounding the employment of its funds 
was foreseen or unless a bank were confronted with 
a serious change for the worse in its affairs. While 
there are neighboring banks with surplus funds 
to lend a bank whose loans are liquid experiences 
no difficulty in securing additional funds by means 
of contraction. Aside from loans to its own de- 
positors, payment for which will ordinarily involve 
a cancellation of its own deposit obligations, it 
is important to observe that the additional funds 
which a bank thus secures come from other banks. 
When banks loans are paid by borrowers, money 
to an insignificant amount is drawn from general 
circulation. The total money holdings of the banks 
are not appreciably increased; there is simply a 
shifting of cash holdings among the banks. 

14. GENERAL CONTRACTION OF LOANS. 
— In periods of active business, however, banks can 
and generally do lend all that their reserves will 
support. If during such a period any considerable 
loss of cash occurs, the foundation of credit is 
weakened and the banks generally may desire to 
strengthen themselves. A policy of contraction 
of loans may then be adopted by most of the banks 
at the same moment. The results of contraction 



24 LOANS AND INVESTMENTS 

in such circumstances are far less effective in 
strengthening the banks than those which follow 
contraction by one or a few banks. Just as when 
loans increase more checks are drawn in payment 
for increased purchases, so when loans are being 
generally reduced more checks are drawn in favor 
of the banks with no corresponding inflow of 
money. The payment of loans does not increase 
the amount of money in the possession of the banks 
taken as a whole; it simply reduces deposit obli- 
gations. Let us suppose, for example, that the New 
York banks have exactly the amount of reserve 
required by law, 18 per cent, of their net de- 
posits. One million dollars is shipped to the in- 
terior, reducing deposits by a like amount and 
reserve requirements by $180,000. There is now 
a reserve deficiency of $820,000. Will the liquida- 
tion of $820,000 of loans bring in the desired amount 
of cash? By no means. The loans will be paid 
with checks on the banks and will reduce deposits 
by $820,000 and reserve requirements by 18 percent, 
of that amount. In order to restore the reserve 
ratio it will be necessary to reduce loans by some- 
thing like four times the amount of cash loss, 
that is, by four million dollars. It will thus be 
seen why the loan market is at times exceedingly 
sensitive to a seemingly small loss of cash. When 
surplus reserves are low, it may involve a contrac- 
tion of loans several times the amount of the cash 
lost. If the cash lost is due to gold exports the 



LOANS AND INVESTMENTS 25 

advance in rates which is certain to accompany 
general loan contraction may make it profitable to 
borrow in foreign markets. Such borrowings often 
bring about the cessation of a gold export move- 
ment. It is seldom possible, however, so com- 
pletely to reverse the exchanges by this means as 
to secure additional cash by means of gold imports. 
15. ULTIMATE EFFECTS OF CONTRAC- 
TION. — Ultimately if contraction entails lessened 
business activity, money will flow into the banks 
from general circulation; but this is a slow and 
uncertain resource of little use in meeting the 
pressing needs which usually occasion the general 
liquidation of loans. The reduction of deposit 
liabilities through contraction will, of course, bring 
the reserve ratio of the banks to a satisfactory 
point if it can be carried far enough. But it cannot 
be carried very far. Business cannot be suddenly 
deprived of that amount of credit which it has been 
receiving without disastrous consequences. When 
the volume of business declines, the volume of credit 
can also be correspondingly reduced but not before, 
except within narrow limits. The credit granted 
to those engaged in one of the last stages of the 
production of some commodities can generally, it 
is true, be reduced without much difficulty. Con- 
sider, for example, the meat and provision business. 
Packers reduce their purchases of cattle and hogs. 
The necessary daily consumption of the people 
soon reduces the stock on hand and as cash pay- 



26 LOANS AND INVESTMENTS 

ments are the rule in this line of business the 
packers will shortly be able to liquidate their loans 
and would require no new accommodation. It 
seems at first sight as if a large amount of com- 
mercial loans would have been eliminated. ButJ 
consider the situation of the large number of 
farmers engaged in the business of raising cattle 
and hogs. Unable to sell as much as usual to the 
packers they would be obliged to fall back upon 
their own banks, from which they would be com- 
pelled to borrow more largely than usual. Even 
call loans are much less liquid than is gen- 
erally supposed. When a few banks demand pay- 
ment of these loans brokers to whom they are 
principally made secure loans elsewhere and the 
banks calling the loans are paid. The total volume 
of call loans is not much changed. Within narrow 
limits it may be possible to reduce the aggregate 
of such loans by sales of securities to persons able 
to pay for them outright. It is also possible to 
secure additional margins from customers for 
whom brokers are carrying securities. But when 
all banks call loans they soon cease to be convert- 
ible. Purchasers who might be able to pay for 
securities outright become frightened, while alarm 
and even panic may become general. In order to 
prevent disastrous failures among brokers and 
consequent loss to themselves the banks find it 
necessary to refrain from insisting upon general 
loan contraction. 



LOANS AND INVESTMENTS 27 

16. GENERAL LOAN CONTRACTION TO 
BE AVOIDED. — In European countries the banks 
never find it necessary to attempt to strengthen 
themselves by sudden and general contraction of 
loans. Slow contraction of loans is of course some- 
times insisted upon when it is thought that the 
business situation will thereby be improved. If 
it is merely a question of strengthening the banks, 
however, recourse is had to the central banking 
institutions found in all European countries. Un- 
like other banks these central banks in ordinary 
times never lend to the full extent of their power 
to grant credit. They are therefore always in 
position to take over a part of the load of loans 
from the other banks. This makes the situation 
in emergencies in European countries analogous 
to what it has been with us when some, but not all, 
of the banks were seeking to strengthen themselves 
by means of contraction. It cannot be expected 
that each one of the many thousands of banks 
in this country will reserve part of its lending 
power for emergencies which after all come but 
seldom. Somewhere in every banking system a 
reserve of lending power is required, and it is 
primarily to meet this requirement that the Federal 
Reserve banks were established in 1914. 

17. ALDRICH-VREELAND ACT— In addi- 
tion to central banking arrangements there is 
another possible method of meeting emergency 
requirements. All banks may be authorized to 



28 LOANS AND INVESTMENTS 

issue a special variety of bank notes subject to a 
tax onerous enough to deprive the banks of all 
inducement to issue them in ordinary times. This 
was the method adopted in the Aldrich-Vreeland 
Act of 1908. This measure proved of the very 
greatest advantage during the crisis of 1914. 
Nearly $300,000,000 of the emergency notes were 
issued, thus enabling the banks to meet all demands 
for currency without entrenching upon their cash 
reserves, and at the same time to aid the business 
community by the granting of additional accom- 
modation. 

18. FEDERAL RESERVE ACT.— Before the 
occasion for testing this legislation, and following 
European example, the Federal Reserve Act was 
passed on December 23, 1913. The Federal Re- 
serve banks were opened for business on November 
16, 1914, just after the crisis of that year had been 
overcome. The primary purpose of the reserve 
banks and the Aldrich-Vreeland notes is similar. 
Both were designed to meet periods of severe finan- 
cial strain, but it is rightly believed that the reserve 
banks will prove more serviceable for this purpose, 
and that they will also be of much advantage in 
ordinary times. In particular, the reserve banks 
are expected to be able to exert a restraining in- 
fluence during the periods of rapid credit expansion 
which always precede crises. It is also believed 
that they will contribute much to the standardiza- 
tion of banking practice, and that they will improve 



LOANS AND INVESTMENTS 29 

methods of making settlements between the banks 
in different parts of the country. 

19. RESERVE BANKS AND LIQUIDNESS. 
— If the reserve banking system works well it may 
reasonably be expected that the course followed 
by banks in making adjustments to variations in 
demands for cash will be materially different from 
what it has been in the past. It will be just as 
necessary as formerly for a bank to keep itself 
in a liquid condition, but the relative liquidness of 
different classes of assets will be somewhat changed 
and the liquidness of all assets will be enhanced. 
The liquidness of all assets will be enhanced if the 
reserve banks maintain themselves in a condition of 
such strength as to be able at all times to supply 
additional credit and currency to meet emergencies. 
The process of conversion of assets into cash will 
then be the simple matter which we have already 
seen it to be when only a few banks experience 
the need of conversion. The process of conversion 
will be a simple matter since it will not involve 
contraction but merely the transfer of assets to 
reserve banks, in exchange for cash. Loan con- 
traction will, no doubt, from time to time occur 
when the volume of business falls off or when there 
is evidence of an over-extended condition of affairs. 
Contraction will be carried through gradually, 
however, so as to conserve all interests so far as 
may be possible. Contraction will not be resorted 
to merely to strengthen the banks. 



30 LOANS AND INVESTMENTS 

20. RESERVE BANKS AND COMMER- 
CIAL LOANS. — As an indirect consequence of 
the operation of the reserve banks it may be an- 
ticipated that all bank assets will be mere steadily 
liquid than in the past. Bonds, for example, will 
be more steadily saleable, and the possibility of 
shifting call loans will be always present. But 
obviously those assets will gain most in liquidness 
which can be used as a basis for loans from the 
reserve banks. Most of the European banks may 
make loans of all kinds both to individuals and to 
banks. In the case of the reserve banks the field 
of operation has been somewhat narrowly pre- 
scribed, though it may be added it includes those 
classes of business which make up the bulk of the 
investments of the European central banks. The 
normal lending operations of the reserve banks 
are limited to the purchase of commercial bills of 
exchange and the rediscounting for member banks 
of commercial loans of all kinds maturing within 
ninety days and of agricultural loans maturing 
within six months. The rediscounting of loans 
secured by stocks and bonds is specifically pro- 
hibited. Commercial loans are generally defined 
in the act as "notes, drafts and bills of exchange 
rising out of actual transactions. That is, notes, 
drafts and bills of exchange issued or drawn for 
agricultural, industrial, or commercial purposes, or 
the proceeds of which have been used or are to be 
used for such purposes." The Federal Reserve 



LOANS AND INVESTMENTS 31 

Board was authorized to define more precisely the 
nature and character of eligible paper. In the 
exercise of this power the Reserve Board has de- 
fined commercial loans in such a way as to include 
all loans to borrowers engaged in production and 
marketing of goods whose current liabilities are 
not in excess of their current assets. Loans of 
this character are everywhere the backbone of the 
banking business. 

21. SOURCES OF PAYMENT OF BANK 
LOANS. — Borrowers derive the means of pay- 
ment of bank loans from a variety of sources. 
The liquidation of many loans is dependent upon 
the sale of property, such as real estate and 
buildings, or of stocks or bonds. Some loans are 
gradually reduced and ultimately paid in full with 
savings made from income and especially from the 
profits of a business. The floating indebtedness 
of a successful business may be liquidated by se- 
curing additional capital, either through the issue 
of new stock or the sale of bonds. Payment of 
particular loans may be accomplished by borrowing 
elsewhere or by postponing the payment of current 
accounts with those from whom goods have been 
purchased. Finally, means of payment may be 
secured during the life of the loan as a natural 
result of the regular operations of a business. In 
the case of particular loans, any one of these various 
means of payment may be regarded as of primary 
importance by the banker, but the bulk of all bank 



32 LOANS AND INVESTMENTS 

loans are based mainly either upon collateral or 
upon the expected results of natural business opera- 
tions. Some loans possess both these elements of 
strength, but more commonly credit is granted 
upon one of them alone rather than both in com- 
bination. 

22. COLLATERAL LOANS.— The business 
of making collateral loans is of a comparatively 
simple nature. The quality of such loans depends 
mainly upon the marketability of the collateral 
pledged as security. Of course there may be sud- 
den unforeseen changes in the value of any given 
security; and in periods of acute financial strain 
there may be a sharp decline in the value of all 
securities, and difficulty may be experienced in 
finding purchasers at any price. Lending can never 
be made a routine mechanical business. But with- 
out minimizing the hazards involved in making 
collateral loans, it is certain that the problems en- 
countered in making loans based on the current 
results of business operations are far more numer- 
ous and complicated. 

23. COMMERCIAL LOANS. — Loans, the 
means of payment of which become available dur- 
ing the life of the loan as a result of the regular 
operations of a business, are commonly known as 
"commercial loans." The instrument in which the 
obligation is embodied may be either a bill of 
exchange or a promissory note. The lender may 
rely for payment upon the borrower alone or re- 



LOANS AND INVESTMENTS 33 

quire additional security — either a lien on tangible 
property or the endorsement of one or more third 
parties. There is, then, much variety among com- 
mercial loans, but they all possess one feature in 
common which overshadows these differences. To 
be a commercial loan, the proceeds must be used 
in financing the production and marketing of goods, 
operations from which the means of payment will 
ordinarily be derived before it matures. The limits 
within which banks may safely finance these opera- 
tions, and the terms on which accommodation shall 
be granted, constitute the complex problem of the 
commercial loan. The financing of fixed assets- 
land, buildings, and machinery — is entirely outside 
the limits of commercial borrowing. No part of 
the indebtedness of a borrower in excess of his 
current assets can be regarded as commercial in 
character. Moreover, to finance anything like all 
of current assets by means of short time loans 
would in almost all instances involve the speedy 
insolvency of the borrower and loss to the banks. 
24. CURRENT ASSETS.— Current assets con- 
sist of materials, work in process, finished goods, 
accounts and notes receivable, and cash. In the 
ordinary course of business all the other current 
assets are in process of conversion through one or 
more stages into cash. At the same time, however, 
it is to be noted that unless a business is being 
wound up, new current assets of each kind are con- 
stantly being acquired. The materials of today 



34 LOANS AND INVESTMENTS 

become the finished goods of tomorrow and the 
receivables of a more distant future. Current assets 
are revolving assets. 

25. CURRENT LIABILITIES.— An analogous 
process is to be observed in the current obligations 
of a business. Indebtedness to banks and to those 
from whom goods are purchased is constantly 
maturing and being paid, but new obligations are 
at the same time being incurred in connection with 
the operations which will result in future sales. 
There must be a constant inflow of cash to a busi- 
ness to meet these obligations as they become due, 
and this inflow must be sufficient, not merely for 
this purpose, but also to provide for the current 
running expenses of the business, to say nothing of 
provision for up-keep and earnings. But since new 
obligations are constantly being created, there is 
always the possibility, in the case of a business 
which is losing ground, that an inadequate inflow 
of cash is being met by using proceeds of new cur- 
rent obligations to meet the burdens of the past 
rather than the operations of the future. Since 
business is a continuing process, it cannot be con- 
stantly subjected to the test of complete liquidation 
of its indebtedness. The supply of cash, therefore, 
may be sufficient to meet maturing obligations for 
a considerable time after a concern is in an unsound 
or even insolvent condition. 

26. METHODS OF DETERMINING SAFE 
LIMITS OF CURRENT LIABILITIES.— Two 



LOANS AND INVESTMENTS 35 

methods of determining whether the current liabili- 
ties of a business are being kept within safe limits 
may be distinguished. Under one method credit 
is based upon the entire financial position of the 
borrower as determined by the analysis of state- 
ments of the condition of his business and other in- 
formation. Under the other method specific trans- 
actions, purchases and sales of goods, measure 
borrowing capacity. Before considering the respec- 
tive merits of these two methods, it is to be noted 
that neither of them has validity — indeed, they 
may be positively misleading — in the absence of 
character and business ability in the borrower. The 
most prosperous business may be quickly ruined 
through mismanagement. Under no method of 
determining proper limits for loans can the pos- 
sibility of loss through dishonesty be entirely 
eliminated. Judgment of men is fundamentally 
essential for the successful conduct of commercial 
banking. But definite rules and principles for esti- 
mating the character and capacity of individuals 
are of little service. In the final analysis, there- 
fore, it will simply be assumed that the banker 
has satisfied himself regarding these essential 
qualifications. 

27. STATEMENTS OF BORROWERS.— The 
honesty of the borrower is especially important 
when statements of the condition of his business 
are used in determining the amount of credit which 
may safely be granted. An independent audit of 



36 LOANS AND INVESTMENTS 

course reduces the danger from fabricated state- 
ments, and such audits are becoming increasingly 
common, although they can hardly be expected in 
the case of borrowers of small or medium size. The 
practice of requiring a statement of condition from 
borrowers has grown during the last twenty years 
until now it is almost universal in well-managed 
banks. It is evidently an imperatively necessary 
requirement where' credit is granted on unsecured 
single name paper. Statements of condition are 
made with varying degrees of completeness. Often 
only a balance sheet is available, but frequently a 
statement of the amount of sales is also given, as 
well as other information. The balance sheet alone 
is commonly the only information furnished pur- 
chasers of commercial paper from note brokers. 
Borrowers naturally are unwilling that detailed 
information regarding their affairs should be spread 
broadcast throughout the country. To the note 
broker, however, more complete information in 
confidence is commonly given. When balance 
sheets alone are available intimate knowledge of 
the industry in which the borrower is engaged is 
needed in order to interpret them. The relative 
amount of various kinds of current assets and lia- 
bilities shown in the balance sheet when compared 
with statements of others engaged in the same line 
of business will often indicate whether it is in a 
sound or weak condition. A single balance sheet 
is of very little significance, but a series of state- 



LOANS AND INVESTMENTS 37 

ments extending over a period of years often throws 
much light upon the conditions and tendencies of 
a business. 

28. RATIO OF CURRENT ASSETS TO 
LIABILITIES. — It is a common rule of thumb 
that current assets ought to be twice the amount 
of current liabilities. This is not a rule for lending 
that should be followed blindly; it is merely a 
suggestion, a sort of guidepost. ^If the current lia- 
bilities are more than one-half the assets it naturally 
puts the banker on inquiry to find out whether the 
rather high proportion of current liabilities to cur- 
rent rent assets is safe. A proportion of 1^4 to 1 
may in certain lines of business be a more satisfac- 
tory proportion than a 2^ or 3 to 1 proportion in 
other kinds of business. 

29. LIQUIDATION OF ASSETS. — It is 
necessary, therefore, to know a good deal about 
the nature of different kinds of business if one is 
to grant credit wisely. There are some kinds of 
business the products of which are universally con- 
sumed and paid for in cash. Concerns engaged in 
such business obviously can borrow more largely, 
and can go along with a lower ratio of assets to 
liabilities, than those engaged in other kinds of 
business. Take a business like that of the packers, 
for instance, who are large borrowers through note 
brokers. It would be possible for such concerns to 
liquidate many millions of dollars in a compara- 
tively short time. All they would need to do would 



38 LOANS AND INVESTMENTS 

be to purchase in the near future a smaller number 
of cattle and hogs. The demand for their products 
would quickly take off the existing supply and they 
would largely be paid in cash. Moreover, they 
would lose no valuable trade connections by cur- 
tailing operations, and possibly they might take 
advantage of the situation to add a few cents to 
the price of their products. 

30. SLOW LIQUIDATION.— Let us consider 
another kind of business, say a furniture manufac- 
turer. It might be that just at the time when he 
would like to reduce his obligations his obligations 
will increase. Let us suppose circumstances in 
which the demand for furniture suddenly falls off 
on account of general reaction in the activity of 
trade. Dealers in furniture would in those circum- 
stances purchase less than the expected supply of 
furniture, and presumably, also, they would defer 
more or less their payments on past purchases. In 
the meantime the maker of furniture would find 
himself loaded up with a large amount of it, for 
the moment unsalable, and he would have no one 
on whom he could fall back, as was the case with 
the dealer. Of course, the furniture maker might 
defer payments for materials to a certain extent, 
but the value of the materials going into furniture 
is small as contrasted with the value of the furni- 
ture itself, as so much of the value of that product 
is due to the labor employed upon the material. On 
this account the delay on the part df the furniture 



LOANS AND INVESTMENTS 39 

maker in meeting his payments for purchases would 
not by any means offset delays on the part of fur- 
niture dealers in making payments to makers of 
furniture. Clearly, then, the furniture maker is a 
concern from which one would demand a higher 
ratio of quick assets to quick liabilities than from 
a packing-house concern. In a general way it may 
be said that those engaged in the last stages of 
production, if they are producing an article which 
enters into necessary and general consumption, can 
extricate themselves from critical credit situations 
more easily than any other class of producers in 
the community. 

31. VOLUME OF SALES.— In the interpreta- 
tion of balance sheets the amount of net sales is 
of great assistance. A rapid turn-over of current 
assets, as compared with that of others engaged 
in the same line of business, is ordinarily an indica- 
tion of a capable and successful management. It 
implies that stocks are wisely purchased; it also 
indicates that dead stock is not inflating the inven- 
tory, and that accounts long past due are not being 
carried. An absolutely high turn-over is also sig- 
nificant. Here there is a wide variation owing to 
differences in the nature of various lines of business. 
The process of production may be long, or the 
terms of payment may be customarily liberal, as in 
the case of agricultural implements. Where these 
conditions are found the ratio of current assets to 
current liabilities should be high — in other words, 



40 LOANS AND INVESTMENTS 

a large part of the current assets should be financed 
by those conducting the business. 

32. LIMITED SIGNIFICANCE OF BAL- 
ANCE SHEETS. — All the information derived 
from balance sheets and other sources is designed 
to determine the liquidating ability of borrowers. 
From balance sheets, however, this ability can only 
be inferred. A balance sheet simply presents a more 
or less accurate statement of the condition of a 
business at some one moment of time. It does not 
give any assurance of the ability of a concern to 
meet its obligations as they mature. It is quite 
possible, however, to secure information about a 
business which will give a clear and direct indica- 
tion of its liquidating possibilities. Moreover, this 
can be done without divulging information which 
might prove helpful to competitors. This method 
of estimating liquidness is also extremely simple, 
but it has as yet been applied by only a few lenders. 

33. RATIO OF COLLECTIONS TO MA- 
TURITIES. — As we have already seen, the inflow 
of cash to a solvent business must be sufficient to 
meet its various maturities and all the other ex- 
penses of the business, and in the case of a pros- 
perous concern, there must be something left for 
profits. A high ratio in cash receipts to the pay- 
ments which must be met, evidently, then, affords 
the strongest possible basis f for the conclusion that 
a business will be able to liquidate its obligations 
in the future. Suppose, for example, that during 



LOANS AND INVESTMENTS 41 

the two previous years the average monthly collec- 
tions of a given manufacturing business have been 
$100,000 ; that the average monthly maturities have 
been $50,000, and average payments on account of 
rent, interest, insurance, taxes and office salaries, 
have been $30,000. By the discontinuance of its 
manufacturing operations it is certain that this 
concern could liquidate its indebtedness unless 
there should be a most severe falling off in the 
demand for its product. As in the analysis of the 
balance sheet, account would necessarily be taken 
of the nature of the business. A higher margin of 
collections would be requisite in some industries 
than in others. This method of testing credit does 
not take the place of balance sheets and other 
sources of information. It simply supplements 
them, though it is believed that in the course of 
time this ratio between collections and maturities 
and fixed charges will come to be regarded as the 
most important single factor in credit analysis. 

34. CREDIT ANALYSIS AND SINGLE 
NAME PAPER.— Analysis of the financial posi- 
tion of the borrower is clearly a necessary safeguard 
in granting credit when a bank relies for payment 
solely upon the unsecured notes of the borrower. 
Under a system of adequate credit analysis a bank 
is able to determine with a reasonable degree of 
certainty not only that the borrower is using the 
proceeds of his loans to finance current assets, but 
that also the amounts of loans are within his 



42 LOANS AND INVESTMENTS 

liquidating capacity. In these two respects, at 
least, single name paper can be quite as satisfactory 
as any other method of borrowing. 

35. TRADE PAPER.— Obligations of the pur- 
chasers of goods to sellers have always been 
regarded as a solid basis for bank credit. The ob- 
ligation may be expressed either in the form of a 
note given by the purchaser and endorsed by the 
seller, or as a bill of exchange drawn by the seller 
and accepted by the buyer. There is no funda- 
mental legal difference between these two instru- 
ments. The principal advantage possessed by the 
bill is that as the initiative is taken by the seller, 
it may be sent with bills of lading attached through 
a bank with instructions to retain the ladings until 
the bill has been accepted or paid. 

36. TRADE AND SINGLE NAME PAPER 
COMPARED. — The commercial character of 
trade paper is obviously more directly evident than 
in the case of single name paper. Names of two 
concerns engaged in businesses which would 
naturally make one a purchaser of the product of 
the other, provide fair evidence that the paper is 
commercial in character. In the case of single 
name paper it becomes necessary to analyze the 
assets and liabilities of the borrower, but this 
method, though indirect, offers equally clear evi- 
dence of the nature of the transaction. Double 
name paper is not infrequently accommodation 
paper, and this fact is not always evident. In cer- 



LOANS AND INVESTMENTS 43 

tainty that a loan is commercial in character there 
is no appreciable difference between single and 
double name paper. The respective merits of the 
two methods o>f borrowing must clearly be de- 
termined by other considerations. At first sight 
it might seem that the risk of loss to lenders must 
be less where trade paper is the basis for loans. 
Tradition is all in favor of the specific transaction, 
and at first sight it would seem self-evident that if 
the maker's own note is good the addition of an- 
other signature could hardly fail to make it still 
better. This conclusion, though equally true in 
the case of any single loan, does not necessarily 
hold good when the character of all current busi- 
ness obligations is to be determined. The two 
kinds of borrowing are the outcome of different 
methods of conducting business. That method of 
lending which is most conducive to the mainte- 
nance of sound and healthy conditions in trade and 
industry will, in final anaylsis, provide a superior 
quality of commercial loan. 

37. CASH PAYMENTS.— Single name paper 
and the bank acceptance have to an increasing 
extent taken the place of double name mercantile 
paper all over the world, except in France, where 
three names are required at the Bank of France, 
The payment of cash for commodities has brought 
this change about. In some lines of business, be- 
cause of the marketable nature of the product, and 
in others because of the strong position of pro- 



44 LOANS AND INVESTMENTS 

ducers, cash payments have been insisted upon. In 
many other lines of business the obvious advantage 
of speedy payment has been sufficient to lead to 
the offer of discounts for cash much above ordinary 
rates for bank loans. When purchasers pay cash, 
obviously the double name mercantile bill or in- 
dorsed note cannot come into existence. Pur- 
chasers must either have enough capital of their 
own to make payments or must borrow directly 
from their banks. 

38. ADVANTAGES OF TRADE ACCEPT- 
ANCES.^ — There is a sharp difference of opinion 
at the present time among bankers with regard to 
the respective merits of single name paper and the 
trade acceptance. The advantages of trade paper 
have been ably presented by B. D. Harris, Vice- 
President of the National City Bank of New York, 
who says : "Under our present account system the 
merchant is compelled to conduct the operations 
of his business involving carrying the accounts of 
his customers to an unreasonable extent. He is 
compelled to do this usually solely on his own 
credit and through the medium of his single name 
paper discounted with his bankers or sold through 
brokers in the open market. Owing to lack of 
accurate knowledge or visible means of knowing 
the character of credits extended by him — and to 
the inconvertibility of the latter — it has come to 
be quite a settled principle that in order to have 
a satisfactory credit footing his statements should 



LOANS AND INVESTMENTS 45 

show a large margin of safety in quick assets of 
this character over liabilities— usually in the pro- 
portion of two for one, or more. No matter how 
sound his credits, he must preserve this proportion 
to float his single name paper successfully, whereas 
were these credits converted into liquid double 
name paper through the medium of acceptances 
or notes, if all conditions were sound they would 
be immediately available and all this large degree 
of lost motion eliminated. If they were unsound 
or of inferior quality, it would become manifest, 
with the result of properly curtailing his credit 
accordingly. For that reason merchants would be 
more careful in extending credits to customers, 
there would be less loss and fewer failures; it 
would to a large extent correct an evil which has 
come frequently under my observation, viz.: that 
in active competition of business many wholesalers 
and jobbers extend unreasonable lines of credit to 
a certain class of small retail merchants, particu- 
larly in small country towns, who operate princi- 
pally on the credit extended them by rival firms, 
and with little or no visible capital of their own. 
This means slow collections and bad debts, and this 
class of customers invariably assign short crops, 
poor collections, the European war, or any other 
conceivable excuse, which may seem most plausi- 
ble, for their inability to pay, and have to be carried 
over. It would strongly curb the pernicious prac- 
tice of over-selling and over-buying. Buyers, 



46 LOANS AND INVESTMENTS 

knowing that their obligations would be discounted 
and their credit put to the test, would be more alive 
to the necessity of meeting their obligations; 
would be more prudent in selling on credit; more 
careful in taking on no larger lines of merchandise 
than they could sell; more certain of their collec- 
tions, and therefore more able to pay their debts. 
Hence the curse of over-expansion, and the grow- 
ing mass of credits which do not liquidate at times 
and seasons when they should liquidate, would 
receive a salutary check. The strain on the mer- 
chants and bankers would be diminished, and the 
credits of the entire country placed on a safer and 
sounder footing." 

39. ADVANTAGES OF SINGLE NAME 
PAPER. — That these desirable results will cer- 
tainly follow the re-introduction of the use of trade 
paper is, however, not universally admitted. In 
favor of single name paper the following argu- 
ments are advanced: "Business is altogether likely 
to be kept in a stronger condition when cash pay- 
ments are the rule than when each producer and 
dealer owes for what he has bought and is owed 
for what he has sold. Many, nay most, men are 
so constituted that in periods of active business 
and general optimism they will buy far more on 
credit than they would have bought if required or 
expected to pay cash. Mercantile credit is far more 
likely to be extended beyond safe limits than bank 
credit, partly because the rate of return on sales 



LOANS AND INVESTMENTS 47 

is greater than that on bank loans, and even more 
because bankers, comparatively speaking, are a 
highly conservative class of business men. Where 
purchasing ability is limited by cash payments, it 
is to be expected that the danger of a generally 
overextended condition of business will be some- 
what lessened. Even where cash discounts are not 
taken, dealers selling goods to numerous pur- 
chasers scattered over a wide territory would find 
the handling of mercantile bills and notes far more 
expensive and troublesome than book accounts 
and direct borrowing from the banks. Moreover, 
on account of the various explicit or implied war- 
ranties generally customary when goods are sold 
from samples by traveling salesmen, many bills 
and notes would not be negotiable instruments, and 
would therefore be unavailable for discounting 
purposes. When this problem is considered from 
the standpoint of the banks the same conclusion 
emerges. If credit is based upon specific transac- 
tions, there is no means of determining whether! 
the amount of borrowing on the sales made hasi 
been kept within safe limits, having regard both 
to the character of the purchasers and to the obli- 
gation of the borrowers to those from whom they 
have purchased. Many notable failures in banking 
history have been due to excessive discounts of 
paper representing actual sales of commodities, 
because purchasers had overbought and the bor- 
rowing sellers were overburdened with obligations 



48 LOANS AND INVESTMENTS 

on account of what they themselves had purchased. 
Borrowing on sales made on a time basis creates 
contingent liabilities, and notoriously, contingent 
liabilities are likely to be regarded as no liability at 
all. Cash payments tend to diminish the contingent 
obligations of borrowers. They free the banks to 
a large extent from the necessity of going behind 
the borrower to the persons to whom he has sold 
his product. In the early years of the evolution 
of borrowing on single name paper it was perhaps 
less safe than double name paper. As the practice 
has become more general, statements from bor- 
rowers and credit analysis have become customary, 
and they are proving potent safeguards. Grad- 
ually a more exact knowledge of the limits within 
which credit can be safely granted to particular 
persons and in different lines of business is being 
developed. This knowledge can never be developed 
satisfactorily if the specific transaction is made 
the basis for credit. Much of course remains to 
be done in the field of credit analysis, and the devel- 
opment of more systematic and frequent business 
statements." 

40. DANGER FROM BORROWING IN 
BOTH WAYS. — Experience alone can decide 
when opinions so radically unlike are advanced with 
reference to the respective advantages of single 
name paper and the bank acceptance. It may, 
however, be stated with confidence that either of, 
these methods of borrowing alone is far more 



LOANS AND INVESTMENTS 49 

satisfactory than both in combination. If a bor- 
rower discounts trade acceptances the quality of 
his single name paper must evidently be changed 
for the worse. In discounting his trade paper the 
borrower has hypothecated the main source from 
which cash flows into his business. During the 
immediate future while both methods of borrowing 
are being tested, the banker must carefully guard 
against the danger that many concerns will attempt 
to borrow in both ways. 

41. BANK ACCEPTANCES.— A bank accept- 
ance is a bill of exchange drawn on and accepted 
by a bank. It is a method of borrowing which 
possesses many of the advantages of both single 
name paper and the trade bill. National banks, 
under an amendment to the Federal Reserve Act 
passed in 1916, are permitted to accept not only 
foreign bills but also domestic bills, accompanied 
by shipping documents or secured by goods in 
warehouses, or a lien on goods sold. In a number of 
the States trust companies and State banks are also 
permitted to enter the acceptance field. The bank 
acceptance is unlike the trade acceptance in many 
important respects. The accepting bank bases its 
readiness to accept upon very much the same con- 
siderations which are taken into account in dis- 
counting single name paper— the character and 
financial position of the borrower, as shown by 
financial statements and other information. It is, 
however, by no means certain that the bank 



50 LOANS AND INVESTMENTS 

acceptance will come to be commonly used in 
domestic business in this country. In Germany it 
is a method of borrowing favored both by banks 
and the business community. In other countries, 
notable England, the use of the bank acceptance 
is confined almost entirely to foreign business. 
This difference in banking practice is apparently 
in large measure a consequence of differences in 
the available supply of funds at the disposal of 
banks. In England, where the supply of funds* 
which the banks would willingly employ in do- 
mestic commercial loans has far exceeded the 
demand, the banks have naturally preferred to dis- 
count rather than to accept for their customers. 
A similar disinclination among bankers, coupled 
with the greater complexity of acceptance arrange- 
ments, as contrasted with the discount of notes 
and payment by checks, will work against the 
general adoption of the bank acceptance in do- 
mestic business in this country. In parts of the 
country where the lending capacity of the banks 
is insufficient to meet local requirements, it is not 
unlikely that much use may be made of the bank 
acceptance. The acceptance of a bank gives to 
the obligation a currency which neither trade bills 
nor single name paper can contain. The purchase 
of acceptances may well prove a profitable and 
satisfactory investment for banks in those parts 
of the country where there is regularly a surplus 
of available funds. 



CHAPTER II 



Agricultural Loans 

42. COMMODITY PAPER. — Agricultural 
loans are not essentially different from industrial 
loans. Both are made to assist in producing ma- 
terial for market, although farm products are, for 
the most part, not ready for human consumption 
when they leave the grower's hands, but form the 
basis for industrial operations that make them 
usable. Farming with live stock raising is the 
characteristic occupation of this country, and this 
is recognized by the Nation and the various States 
in the creation of agricultural departments in their 
plans of administration, by the establishment of 
agricultural colleges, and by various special enter- 
prises intended to promote better farming. The 
Federal Reserve Act and rulings of the Federal 
Reserve Board wisely contain provisions granting 
special privileges to agricultural and live stock 
paper. Few things marketed from the farm can 
be produced in ninety days, which is the maximum 
maturity for other paper eligible for purchase by 
Federal Reserve Banks. Agricultural and live stock 
paper having more than three but less than six 
months to run, however, may be received for dis- 
count by Federal Reserve banks to an amount to 
be fixed from time to time for each Federal Reserve 
bank by the Federal Reserve Board. The market- 

51 



52 LOANS AND INVESTMENTS 

ing of staples such as cotton and wheat is a diffi- 
cult problem. The time they are ready for sale 
cannot be controlled and distributed throughout 
the year, as in the case of manufactured articles, but 
is regulated by seasons and weather conditions; 
and, with moderate variation, each crop is ready 
in all sections at about the same time. Transporta- 
tion facilities are inadequate to move such vast 
quantities immediately, storage room can not be 
provided at the various mills which will consume 
it, and prices would of course be demoralized if the 
entire crop were thrown on the market at one time. 
Thus much of these staples remains in the hands 
of producers for a time, and is sold gradually. 
When properly stored and otherwise complying 
with regulations, such goods may be used as se- 
curity for "commodity paper," which is eligible for 
discount by Federal Reserve banks at favorable 
rates. 

43. GRAIN CROPS.— The leading crops are 
wheat, corn, oats and barley. The term "grain," as 
used in banking and commodity exchange circles, 
usually applies to these four products, but it may 
be used to include flaxseed, rye and buckwheat. 
About 200,000,000 acres of land are devoted to the 
production of the country's grain crops. The prin- 
cipal wheat growing States are North Dakota, 
Kansas, Minnesota, Nebraska, Washington, Illi- 
nois, Indiana, Missouri, Ohio, South Dakota, Penn- 
sylvania, Montana, Oklahoma, Iowa and Oregon. 



LOANS AND INVESTMENTS 53 

The country's wheat crop, in recent years, has 
varied from about 635,000,000 bushels to about 
900,000,000 bushels. Over 70 per cent, of the 
world's annual corn crop is grown in the United 
States. In recent years the American crop has 
varied from 2,447,000,000 bushels to about 3,125,- 
000,000 bushels. The principal corn producing 
States are Iowa, Illinois, Missouri, Ohio, Indiana, 
Kansas, Nebraska, Texas and Oklahoma. The 
annual oats crop of the United States ranges from 
about 953,000,000 bushels to 1,419,000,000 bushels. 
It is equal to from 20 to 30 per cent, of the world's 
crop. The annual barley crop of the United States 
varies from 136,500,000 bushels to 233,800,000 
bushels. Generally speaking, grain is shipped in 
bulk. This is true of interior shipments when made 
by rail or water carriers, and of shipments for 
export. The only exceptions are grain handled 
on the Pacific Coast, where it is usually packed in 
sacks, and in special export shipments to Africa 
and Australia. 

44. GRAIN ELEVATORS AND WARE- 
HOUSES. — "Grain elevator" is a term applied to 
a storage warehouse for grain. Elevators are 
either owned by grain producers, by jobbers, by 
warehouse companies, or by railroad carriers. 
Some elevators are privately owned and used by 
the owner for storing the grain purchased by him. 
Others are operated as public warehouses. Usually 
the grain of various owners is placed in the same 



54 LOANS AND INVESTMENTS 

bin, care being taken that all of grain deposited 
in a particular bin is of the same grade and quality. 
Where grain is thus placed in elevators, the identity 
of individual lots is lost. Special arrangements 
may be made in the case of public elevators for 
the preservation of identity, but higher storage 
rates must be paid under those circumstances. 
Country elevators, relatively small in capacity, are 
to be found all over the grain-producing sections 
of the country. They serve the purpose of locally 
concentrating the crop raised in each small district, 
before the same is shipped to one of the central 
markets. Each farmer hauls his grain to the near- 
est elevator, where it is conveniently weighed and 
then dumped into the elevator. The owners of 
these country elevators usually purchase for cash 
the grain delivered by the farmers, and they in turn 
sell the accumulated supply to dealers located in 
the larger centres. There are four principal 
classes of country grain elevators: first those 
operated by "line companies" ; second, those owned 
by local grain dealers; third, those operated by 
farmers' co-operative associations or companies, 
and fourth, those run by mill owners and malting 
concerns. "Line companies" are corporations 
which own and operate a chain of elevators along 
one or more railroad routes, and which have head- 
quarters in primary markets, to which shipments 
are made of the grain bought and collected from 
farmers. 



LOANS AND INVESTMENTS 55 

45. MARKETING GRAIN. — Owners of 
country elevators pay the farmer for his grain as 
soon as it is weighed and deposited. Owners of 
local country elevators, whether they be small 
dealers or line companies, obtain financial assist- 
ance by borrowing money from banks on shipping 
documents covering the grain sent to primary mar- 
kets. Money is also borrowed on grain stored in 
the elevators, insurance certificates being required. 
The grain which is not consumed locally finds its 
way, sooner or later, to one of the primary markets, 
which are large distributing centres for domestic 
and export trade in wheat, corn, oats and barley. 
The sixteen leading primary grain markets are 
Chicago, Minneapolis, Kansas City, St. Louis, 
Duluth, Milwaukee, Omaha, Peoria, Louisville, 
Cincinnati, Indianapolis, Toledo, Cleveland, De- 
troit, Wichita and Little Rock. The aggregate 
receipts of these markets are greatly in excess of 
1,000,000,000 bushels and the shipments amount to 
from 60 to 65 per cent, of the receipts. Not only 
are large supplies of grain concentrated at these 
primary markets, but facilities are afforded in these 
cities for cleaning, mixing, weighing, grading and 
storing the grain gathered from the numerous local 
markets. There are grain exchanges in these 
centres, and many milling and malting establish- 
ments are located there. The elevator warehouse 
facilities are naturally larger than those found in 
the smaller cities, and usually these warehouses 



56 LOANS AND INVESTMENTS 

are subject to inspection and supervision by State 
authorities, or by the exchange authorities, or by 
both. Elevators located in the primary markets 
are equipped with machinery for loading and un- 
loading grain on and from water and rail carriers. 
Some of these elevators are "floating" warehouses, 
and may be moved close to ships bringing in 
grain. They are also equipped with hoppers, clean- 
ing machines, dryers, blowers and scouring plants. 
The leading seaboard markets are New York, Bal- 
timore, Philadelphia, Boston, New Orleans, San 
Francisco, Puget Sound points, and Portland, Ore. 
Grain is also exported by lake through the Welland 
Canal and via the St. Lawrence river from Chicago, 
Duluth, Detroit and other Great Lake ports. 

46. STATE AND FEDERAL REGULA- 
TION. — Some of the States have laws governing 
the operation of public grain elevator warehouses. 
Many of the laws specifically prohibit discrimina- 
tion in charges and services and require licensing 
and bonding of warehouse proprietors. Provisions 
are also made for the issuance of reports showing 
the amount of grain stored, and in some cases it 
is required that the grain should be graded and 
weighed and certificates issued by State grain in- 
spectors. The warehousemen are authorized to 
issue negotiable receipts upon which must be 
stated the quantity and grade of the grain stored. 
Public elevators in Chicago, for instance, are also 
required to register all receipts issued. Under the 



LOANS AND INVESTMENTS 57 

Federal Grain Standards Act, passed in August, 
1916, the Secretary of Agriculture was vested with 
authority to prepare standards of various grades 
of grain that may be traded in. The law also 
authorizes Government supervision of the work of 
State inspectors and inspectors engaged by grain 
exchanges. 

47. GRAIN EXCHANGES.— The grain ex- 
changes operate inspection departments or bureaus, 
the function of which is to inspect the grain stored 
in the terminal elevators. All the grain which is 
received in Chicago or New York is inspected and 
certificates are issued. Exchanges usually publish, 
a list of approved elevators. The inspection by the 
exchanges prevents the delivery of unmerchantable 
grain or of grain of a quality inferior to the one ; 
called for. The exchanges establish the grades, 
regulate the mixing, and weigh all the grain re-, 
ceived. Small fees are charged for the inspection. 
Canadian grain received "in bond" for trans-ship- 
ment to foreign ports is not inspected, but is only 
weighed. Members of the grain exchanges trans- 
act business both in "spots" and in "futures." The 
relative prices- at the different markets are largely 
influenced by the cost of transporting the grain, 
but also by other factors, such as the local supply 
and demand, the world's supply and demand, and 
other considerations governing price fluctuations 
in commodities. Dealers in grain, and the millers 
who produce flour, utilize the machinery of the 



58 LOANS AND INVESTMENTS 

exchange for "hedging" purposes — just as cotton 
merchants and spinners use the cotton exchanges 
to protect themselves against price movements. 

48. GRAIN LOANS. — Grain stored on the 
farm may be covered by a mortgage and thus 
form the basis for a loan by a country bank. The 
farmer sells his grain for cash to a local buyer. 
The buyer usually owns or leases a grain elevator, 
which he fills as the farmers haul in their products. 
He may have sufficient capital to carry on his busi- 
ness, but as a rule borrows some money from his 
local bank. The loan may be made on his general 
assets or secured in some way, but as the grain he 
buys is not in a public warehouse and is constantly 
coming in and going out, it is not the most desirable 
class of collateral. He will ship out about as rap- 
idly as possible, using the capacity of his elevator 
to take up the slack between receipts from the 
farmers' wagons and shipments as freight cars are 
furnished by the railroads. 

49. SALES MADE BY GRAIN BUYERS.— 
The buyer will sell mostly to grain dealers in the 
nearest grain center. Sales will be made on con- 
tract or on consignment. If on contract, the buyer 
agrees to furnish a given quantity of grain of a 
certain kind and quality at a certain price and 
within a certain time. If on consignment, the 
buyer sends the cars to grain dealers who sell 
to the best advantage on the open market, and 
account for the proceeds to the local buyer, less 



LOANS AND INVESTMENTS 59 

the commission. In either case the grain dealer 
finances the local buyer during the time the grain 
is in transit from the country elevator to the city. 
Assuming that he is satisfied as to the buyer's 
character and financial responsibility, the grain 
dealer will authorize him to draw a sight draft on 
him, with shipper's order bill of lading attached, 
for nearly the full value of the car of grain. The 
buyer deposits the sight draft in his local bank, 
which may or may not charge him something for 
making the proceeds immediately available, and 
thus enabling him to pay for more grain. The 
draft will be presented to the grain dealer in the 
city one day or several days before the car of grain 
arrives by freight. On the evidence of the attached 
bill of lading, the grain dealer pays the draft on 
presentation, and when the car arrives adjusts with 
the buyer any difference between its net value and 
the amount of the draft. 

50. CREDIT GRANTED BY BANKS.— It 
is evident that a grain dealer doing a large business 
will soon have a considerable sum of money ad- 
vanced on cars in transit. He will probably arrange 
with his bank for a loan up to a certain amount on 
his unsecured note, called his "open line," and for 
a certain additional amount to be secured by bills 
of lading or warehouse receipts. Order bills of 
lading are receipts from railroads or other common 
carriers covering given quantities of certain goods 
to be transported and delivered only on the order 



60 LOANS AND INVESTMENTS 

of the shipper. The country buyer endorses the 
bills of lading before attaching them to these drafts. 
While lacking some qualities which would make 
them perfect negotiable instruments, the order bills 
of lading are so regarded in practice, and are read- 
ily accepted as collateral to loans to grain dealers. 
Such loans are nearly always made payable on 
demand, as the total amount being used by the bor- 
rower varies from day to day. Substitutions of 
collateral are made daily also, as some cars arrive 
and the bills of lading are taken out, and others 
given the bank on new cars in transit. It is not 
uncommon for a bank to deliver to the borrower 
on his trust receipt collateral of this kind for which 
he will return substitutes later in the day, 

51. WAREHOUSE RECEIPTS AS COL- 
LATERAL. — The grain dealer may sell the grain 
he receives to mills or other dealers locally, in which 
case he receives immediate payment. Or he may 
sell to mills or dealers in some other city, in which 
case he will draw sight draft with bill of lading 
attached, much as the country buyer did in ship- 
ping to him. If public warehouse facilities permit, 
some dealers and mills will store grain for future 
sale or use. While theoretically warehouse receipts 
cover particular grain in certain bins or tanks, it 
is necessary to move wheat frequently to prevent 
spoilage, and thus different lots of wheat in some 
places become mixed with other lots of the same 
grade. Where delivery of grain in Exchanges or 



LOANS AND INVESTMENTS 61 

Boards of Trade is made by means of warehouse 
(elevator) receipts, it is customary to require that 
bond be furnished to the Board of Trade by elevator 
operators and that weighers for the Board check 
all grain in and out, on whose reports receipts 
issued by the elevator are registered by the secre- 
tary of the Board. Elevators so bonded and con- 
trolled are called "regular." Warehouse receipts 
accompanied by insurance policies are thus good 
collateral. Banks loan on them freely with mar- 
gins of, say, ten to twenty per cent. Loans on ele- 
vator receipts are more likely to be time loans, and 
are frequently sold through brokers or to banks 
in other cities who are seeking investments. This 
is particularly true when the local banks are carry- 
ing full lines for the borrower or are loaned up 
closely. As substitution of collateral is often de- 
sired, it is a common arrangement for the local 
bank to hold the collateral on notes sold elsewhere, 
issuing collateral trust certificates to accompany 
properly identified notes. These certificates show 
that the local bank holds collateral of estimated 
value sufficient to cover the loan and is authorized 
to exchange same to the borrower for others of 
equal value. Notes of good firms so secured are 
desirable investments. Loans on grain stored in 
public warehouses are classed by Federal Reserve 
Banks as "Commodity Paper" and given a prefer- 
ential discount rate. 

52. COTTON AND ITS PRODUCTION.— 



62 LOANS AND INVESTMENTS 

The principal cotton-growing States are Texas, 
Georgia, Alabama, Mississippi, Oklahoma, South 
Carolina, Arkansas, North Carolina, Louisiana, 
Tennessee, Florida, Missouri and Virginia. Some 
cotton is also produced in the States of California, 
Arizona, Kansas, New Mexico and Kentucky. The 
planted acreage in recent years has totaled from 
31,500,000 to 37,500,000 acres, the first four States 
named contributing about two-thirds of the aggre- 
gate. The production of cotton in the United 
States during the past ten years has varied from 
about 10,300,000 bales of 500 pounds each, to more 
than 16,900,000 bales. The yield per acre averages 
from about 187 to 194 pounds, or slightly less 
than four-tenths of a bale. The United States pro- 1 
duces about 60 per cent, of the world's crop of cot- 
ton which is available for mill consumption. About 
sixty per cent, of each American crop is exported, 
nearly four-fifths of the foreign shipments going 
to Great Britain, Germany and France. 

53. COTTON RAISERS.— Cotton is raised in 
the South either by the homeowner, to whom the 
plantation belongs, or by the tenant farmer, who 
rents the cotton field from the landowner. The 
payment of money rent is sometimes, but not gen- 
erally, practiced, and the tenant farmer usually ar- 
ranges to pay his landlord on a percentage basis 
of the crop. The two main methods are (1) the 
landlord and tenant agree that the proceeds of the 
crop shall be divided evenly, the land-owner fur- 



LOANS AND INVESTMENTS 63 

nishing the land, houses, horses, feed and the tools, 
and the tenant supplying the labor; (2) the land- 
lord agrees to furnish only the land, in which case 
the terms provide that the tenant shall pay over 
to the landlord only one-quarter of the net pro- 
ceeds of the crop. The Southern States have 
stringent lien laws which protect the landlords. 
Arrangements for renting cotton farm land are 
usually perfected before Christmas, and the tenant 
assumes occupancy on the first of the year. Be- 
sides the land, he is given possession of a small 
house, fitted with a stove, a barn and pasturage. 
A tenant farmer is supposed to have the necessary 
implements and live stock. 

54. MONEY NEEDS FOR PLOWING.— 
Having possession of the land, the tenant-farmer 
begins plowing. Whatever little money he may 
have saved up from the previous year's cotton crop 
is soon spent for food, and the farmer is soon 
obliged to buy on credit. He opens an account 
with a local supply house. The store may give him 
an open credit, or it may require the farmer to 
give his note, payable in the Fall. In certain cases 
the store insists that the notes be secured by a 
chattel mortgage on the farmer's implements. 
Frequently the farmer, in order to obtain credit 
from the supply house, is obliged to mortgage his 
interest in the growing crop. Sometimes he goes 
to his bank and obtains credit by executing such 
a mortgage. The money borrowed from the bank 



64 LOANS AND INVESTMENTS 

he uses to buy for cash instead of opening credit 
at the supply house. The owner of the supply 
store in the South, having received little cash from 
his customers, is obliged to buy his goods also on 
credit. The usual practice is for him to either 
discount his note at the bank, depositing as col- 
lateral a bundle of notes he had received from his 
tenant-farmer customers, or else to present his 
own note to the wholesaler with the bundle of 
customers' notes. 

55. PLANTING AND PICKING. — The 
planting of cotton begins either in the latter part 
of March or early in April. The plant begins to 
grow in May or June, and then it is time to begin 
"chopping," that is, to cut out the surplus growth, 
reducing the sprouted stalks to a "stand," remove 
the weeds and clean up the soil. To do this work 
the farmer will hire labor, but in most cases he and 
his family will do their own "chopping." After 
the "chopping" and until picking time the farmer 
devotes his efforts to cultivating the field, and this 
process keeps him busy during the months of July 
and August. In Texas, cotton picking begins in 
the middle of July, but in other parts of the cotton 
belt the picking season does not start until about 
the first of September. Men, women and children, 
many of them colored, are employed in picking 
cotton. They are mostly piece-workers, few being 
paid on a weekly wage basis. The cotton farmer, 
having waited many months for the fruits of his 



LOANS AND INVESTMENTS 65 

labor, uses all haste to rush his first bale to market 
in order to get cash for it. The rush to market of 
first bales invariably creates a currency strain, be- 
cause the small country banks are suddenly called 
upon to pay out a large sum of money in cash. The 
farmer needs the money to pay his laborers. 

56. GINNING OF COTTON.— Cotton, as it 
is picked, is hauled in loose shape by the farmer 
to the gin, where the lint is separated from the 
seed. In some cases the owner of the gin retains 
part of the ginned cotton as compensation for his 
services, but in other cases the ginner is paid in 
cash, so much per hundred pounds. After ginning, 
the cotton is put through the press, from which 
it comes out in neatly packed and strapped bales. 

57. MARKETING COTTON.— After the cot- 
ton is packed in bales the farmer takes it to market, 
where he disposes of it to "cotton factors," or to 
"cotton buyers." Cotton factors act as selling 
agents for the farmer. Sometimes they sell the 
cotton immediately, sometimes they hold it, and 
sometimes they ship it to a central market, where 
better opportunities are presented for disposing of 
the staple at advantageous prices. These cotton 
factors charge the farmer for storage, for trans- 
portation, for insurance, and a commission for their 
services. In recent years the cotton factorage busi- 
ness has become proportionately less important 
than heretofore. Cotton buyers are representatives 
of cotton merchants and cotton exporters whose 



66 LOANS AND INVESTMENTS 

principal offices are located in the larger cities in 
the South or in New York. Cotton buyers are 
stationed in small towns throughout the South 
where it is convenient for the farmers to bring 
their cotton. The farmer hauls his few bales to 
a local market where he meets the buyer. The 
latter inspects the cotton by cutting into the bale 
to draw samples, and then quotes the price he is 
willing to pay. The farmer, if dissatisfied with 
the offer, may submit his cotton to sampling by 
another buyer who may make a more attractive 
offer. 

58. COTTON TICKETS.— If buyer and seller 
agree upon a price the farmer is handed a ticket 
upon which the purchaser marks the price per 
pound that is to be paid. The farmer takes his 
cotton to a designated weigher, who marks on the 
ticket the weight of each bale. The cotton buyer 
does not always give the farmer a check for the 
cotton, but often expects him to take the "ticket" 
to the bank after it is properly filled out by the 
weigher. When the farmer presents the ticket to 
the local bank, the bank figures out the money due 
him, country banks being equipped with cotton 
tables which facilitate calculating the value of each 
bale. The farmer is paid in cash, or else he is 
advised to permit the bank to put to his credit 
the proceeds of the sale of the cotton. 

59. BANK ADVANCES MONEY TO COT- 
TON BUYERS.— The cotton buyer arranges with 



LOANS AND INVESTMENTS 67 

his bank that it should pay upon presentation of 
the tickets, but at the same time the cotton buyer 
usually does not have the necessary funds to his 
credit in the bank, and consequently the bank is 
called upon to make advances. The bank either 
permits the cotton buyer to overdraw his account 
during the day and give a note for same at the close 
of day — retaining the cotton tickets as security, 
— or else the cotton buyer is called upon to give 
a draft on the cotton merchant or exporter, whose 
agent he is. These cotton tickets are tantamount 
to certificates of ownership, and cotton cannot be 
moved without presentation of the tickets. The 
financial strain in the South resulting from the 
production of the cotton crop begins about June 1st 
in Texas and reaches its height about August 1st. 
The seasonal demand for money invariably necessi- 
tates borrowing by Southern banks from their cor- 
respondents in the East. In view of the fact that 
during the cotton picking season producers are 
in need of cash to pay their help, the Southern 
banks not only require bank credits but they are 
obliged to call upon their central reserve city cor- 
respondents to ship them currency. 

60. COLLATERAL FOR BANK LOANS.— 
The country banks borrowing in New York for 
crop purposes usually forward to their correspond- 
ents collateral in the form of notes, drafts and 
chattel mortgages which have been received from 
merchants and farmers. The Southern bank 



68 LOANS AND INVESTMENTS 

usually executes its note and sends the collateral 
in a large bundle. The New York bank examines 
the same, but hardly ever has occasion to touch 
it, inasmuch as the Southern bank is always ready 
to take up its note at maturity. In the event that 
it is not in position to do so, the New York institu- 
tion will agree to a renewal of the note for another 
month or two. Money borrowed by Southern 
banks in August and September is usually paid 
by the end of November. 

61. LOANS ON COTTON IN WARE- 
HOUSES. — While the cotton buyers purchase 
cotton from the farmers as soon as the cotton is 
ginned and baled, they are not in a position to 
dispose of the staple until they accumulate a sub- 
stantial shipment. Consequently, pending the de- 
livery of cotton to American mills and to foreign 
spinners, the cotton merchant (for whom the buyer 
has been acting) is obliged to place his cotton in 
storage in warehouses, cotton yards and on com- 
press platforms. Requiring funds to carry the same, 
or to buy more cotton, the merchant obtains a loan 
from his bank, secured by a warehouse receipt. 
Bankers who are asked to advance money on ware- 
house receipts for cotton do not only take into con- 
sideration the character and responsibility of the 
borrower but they examine into the safety of the 
warehouse and the financial standing of the ware- 
houseman. Warehouses, in issuing receipts, usually 
inspect the cotton, weigh the bales and furnish a 



LOANS AND INVESTMENTS 69 

receipt describing the quantity and quality of the 
cotton placed in their care. Congress passed a bill 
in August, 1916, which provides for the Federal 
licensing and supervision of warehouses where 
agricultural products, such as cotton and grain, 
are stored. It is believed that banks will now be 
willing to advance money on warehouse receipts 
more freely than they have been in the past. 

62. ASSISTANCE OF FEDERAL RESERVE 
BANKS. — Notes and drafts secured by approved 
warehouse receipts for cotton are rediscountable 
at the Federal Reserve banks. A special rate for 
this character of paper, lower than the trade ac- 
ceptance rate for the same maturity, has been 
established by the Reserve banks in the South with 
the approval of the Federal Reserve Board. This 
special "commodity rate" applies to paper not 
having more than 90 days to run. The assistance 
rendered by the Reserve banks has made it possible 
for banks in the South to charge lower rates to 
customers who elect to carry cotton in warehouses 
pending the receipt of orders for the same, or in 
the hope of obtaining higher prices for the staple 
at a later date. By being able to rediscount paper 
secured by warehouse receipts, the banks have been 
placed in a position where they have a larger supply 
of funds available to borrowers. In recent years it 
has been customary for the Secretary of the Treas- 
ury to make deposits of Government funds with 
Southern banks during the crop-moving: seasons. 



70 LOANS AND INVESTMENTS 

This has had the effect of instilling confidence in 
growers and merchants, and has helped in prevent- 
ing or abating money stringencies. Since Decem- 
ber 31, 1915, instead of depositing Government 
funds with National banks, the Secretary of the 
Treasury has made deposits with the Federal Re- 
serve banks in the South. 

63. COTTON MERCHANTS AND EX- 
PORTERS. — Concerns which buy cotton from 
farmers and factors are known as "spot houses." 
They deal in all grades of cotton and sell to do- 
mestic as well as foreign spinners. Many of these 
houses maintain offices or headquarters in New 
York and some operate from New Orleans, Dal- 
las, Galveston, Memphis and other cities in the 
South. The price offered the farmer by the 
buyer who examines the cotton largely depends 
upon the quality of the cotton. The merchant or 
exporter is very much concerned with the grade 
and length of cotton, for the reason that spinners, 
in making purchases, usually specify in detail the 
character of cotton they require. One grade may 
be available for one mill and be practically of no 
value to another. 

64. CLASSIFYING COTTON.— The work o! 
grading or classifying cotton is a specialty. Ex- 
perts are not common. In many instances a single 
bale of cotton will contain several grades, but as» 
a rule some one particular grade is found in pre- 
ponderance. Moreover, cotton varies according to 



LOANS AND INVESTMENTS 71 

the place of production, and it is the function of 
the spot dealer to be familiar with all grades and 
markets, and to be able to supply the exact grade 
required by particular customers. When a spot 
house receives an order for 100 or 1,000 bales of a 
particular grade, it must gather the necessary 
quantity together from all parts of the South if it 
finds that it has not the required cotton in its store 
or warehouse. 

65. FINANCING EXPORTS OF COTTON. 
— When the cotton exporter in the South receives 
an order to ship 1,000 bales to Liverpool at a fixed 
price, he delivers the cotton to a railroad or to an 
ocean carrier, if he happens to be located at a sea- 
port, and secures a through bill of lading. The 
price determined upon is usually what is known as 
"C. I. F. & 6%," i. e., cost, insurance and freight* 
and 6 per cent, for tare deducted. The shipper has 
the cotton insured. He draws a 60 or 90 day draft, 
payable to himself, for the invoice value of the 
cotton. This he indorses on the back in blank. 
The draft or bill of exchange is drawn either upon 
the foreign cotton merchant or spinner to whom the 
cotton is being shipped or upon a foreign bank 
which has an arrangement with the purchaser to 
accept his bills. The Southern cotton shipper sells 
the draft with the attached bills of lading and in- 
surance certificate to his bank, or sends the draft 
with the documents to a broker in New York, who 
sells the draft to some New York institution. The 



72 LOANS AND INVESTMENTS 

shipper must pay a small commission to the bank 
and a commission to the broker. The bank buying 
the draft pays for it in dollars, according to current 
rates of exchange, the equivalent of whatever 
foreign money the draft may call for. The bank 
buying the bill forwards it to a correspondent 
abroad, who presents it for the purposes of "ac- 
ceptance" to the purchaser of the cotton or to the 
latter's bank. After the bank stamps its acceptance 
upon the bill the same is sold and bought in the 
open market until maturity, when it is paid. 

66. COTTON EXCHANGES.— In the United 
States there are only two markets for "cotton 
futures," one in New York and the other in New 
Orleans. Members of the cotton exchanges lo- 
cated in these two cities deal in contracts for the 
future delivery of cotton. The contract traded in 
is a basic one, that is, it provides for the delivery 
of cotton of a basic grade, middling, and provision 
is made for adjustments in cases where the cotton 
actually tendered for delivery is not of the basic 
grade but consists of a number of bales of a higher 
grade and a number of bales of a lower grade. 
Under the form of contract traded in, the seller has 
the option to deliver any of the established grades, 
price adjustments being made for differences in 
grades in accordance with relative prices for the 
various grades established by the "fixed differences" 
of the exchange. The functions of the exchanges 
are to provide a continuous market, to disseminate 



LOANS AND INVESTMENTS 73 

trade and crop information, and to afford an organ- 
ization where future conditions and events may 
be systematically discounted, all of which tend to 
establish world prices for the commodity. More-, 
over, the exchanges are used for speculation. Ac- 
tivity along those lines helps to establish a proper, 
price level and incidentally aid in distributing the; 
money losses and profits involved in assuming the 
inevitable economic risks of changes in value. 

67. PROCESS OF HEDGING.— Besides fur- 
nishing means for establishing market prices, one 
of the chief services rendered by cotton exchanges 
is that of providing the necessary machinery for 
hedging. Hedging is in the nature of insurance or 
protection against loss occasioned by price fluctua- 
tions. The hedging practice is resorted to by cotton 
merchants, by spinners and by manufacturers of 
cotton goods. A Southern cotton merchant, con- 
tracting in July to deliver 1,000 bales of cotton to 
a spinner in January, will frequently instruct his 
broker on one of the exchanges to buy for him a 
"future contract" for the same quantity of cotton 
deliverable in January. If by the time the merchant 
delivers the cotton to the spinner the price has 
advanced two cents a pound above that at which the 
contract was made, the merchant stands to lose two 
cents a pound. He, therefore, instructs his broker 
to sell out his "futures" on the exchange. Inas- 
much as the price of "futures" and the price of 
"spots" usually fluctuate in unison, it is safe to 



74 LOANS AND INVESTMENTS 

assume that the loss the merchant suffered in the 
one transaction he will have wholly or partially 
recouped by the profit on the other. The prices 
paid to growers and the prices at which cotton is 
sold to domestic and foreign spinners are based 
largely upon the price of futures quoted on the 
exchanges. 

68. UNITED STATES COTTON FUTURES 
ACT.— As amended by the Act of August 11, 1916, 
the United States Cotton Futures Act of February 
18, 1915, provides for Government regulation of 
trading in contracts for the future delivery of cot- 
ton. Briefly, it imposes certain requirements for 
the conduct of business on the cotton exchanges, 
and imposes a penal tax of two cents per pound 
in the event that transactions are not carried on in 
accordance with the specifications. The law vests 
with the Secretary of Agriculture authority to pre- 
pare and promulgate standard grades of cotton. 
The law also makes provision for the settlement 
by the Agricultural Department of disputes arising 
between buyer and seller. The amendment to the 
act provides for trading in specific contracts. 

69. LIVE STOCK LOANS.— Live stock rais- 
ing is one of the most important factors in the 
economic life of our nation. Horses and mules as 
work animals are almost indispensable to agricul- 
ture; sheep and hogs produce great wealth in meat, 
wool, lard, etc.; but cattle are the greatest source 
of income, giving us beef for ourselves and for 



LOANS AND INVESTMENTS 75 

export, hides for leather, milk, butter, cheese and 
the innumerable by-products of packing houses 
which increase returns so largely. They are the 
basis for many loans and of great interest to bank- 
ers. Farmers are realizing more keenly and more 
generally than ever that the best way to market 
corn, hay and other feedstuffs, is on the hoof, or as 
dairy products, and that by so doing they not only 
obtain the greatest return for their salable crops, 
and use some which would otherwise be worthless, 
but they can return to the soil much of its fertility. 
Cattle are raised in every State in the Union, both 
for beef and for dairy purposes. It is claimed that 
no breed of cattle combines satisfactorily milk and 
beef qualities, and for convenience we will consider 
them divided into these two classes. 

70. DAIRY CATTLE.— Scientific dairying is 
highly developed in Wisconsin, Minnesota, Ohio, 
Pennsylvania, New York, Iowa and certain other 
States, where it has been carried on successfully 1 
for many years, and herds of registered and other 
high grade cattle are the rule. The income from 
animals of this type can be anticipated with reason- 
able certainty. Loans to owners are commonly 
made on their showing of assets, including cattle, 
and not on chattel mortgage security. Such loans 
to experienced and responsible men are most de- 
sirable. Dairying is a growing industry in many 
States in addition to those named. The rapid 
increase of population in cities, and the stronger 



76 LOANS AND INVESTMENTS 

demand universally for milk and milk products of 
high sanitary standard, have made it increasingly 
profitable. The establishment of creameries and 
condensaries has helped greatly. In some sections, 
such as Kansas and Oklahoma, bankers have 
brought in good young cows from well-known dairy 
herds and sold them, one or two or three to a man, 
lending him the whole amount of the purchase price 
with a mortgage on the cows as security. When 
care is used in selecting the men with whom this 
arrangement is made, it soon results in a profit to 
both banker and farmer, and, better still, helps in 
the upbuilding of the community from which the 
bank draws its support. In new countries the wife's 
few cows (with the help of the chickens) have often 
brought in the only cash income the family had 
while they established themselves and raised a crop. 
Agriculture received the man's thought and effort 
for a few years because it required less capital and 
brought quicker returns than livestock raising. 
When his finances permitted he branched out into 
fattening some cattle on his grain and thus making 
two profits. Dairying came much later on, when 
the price of milk advanced, its marketing became 
convenient and the continuous income offered at- 
tractions. So all through the farming section of 
the central plains States will be found these stages 
of evolution; not that dairying crowds out feeding, 
but it finds its own place, stays, and adds to the 
growing wealth of our nation. Bankers may sus- 



LOANS AND INVESTMENTS 77 

tain losses on loans for pretentious attempts in 
dairying by inexperienced men with high-priced 
cattle, but loans of moderate amounts to capable 
and industrious men for the purchase of dairy cows 
are thoroughly sound. 

71. BEEF CATTLE. — The raising of cattle 
for beef purposes is likewise a science. It must be 
remembered that while a great many animals in 
the aggregate remain in the hands of their first 
owners until sold for slaughter in a local abbattoir, 
others are sold half a dozen times and are shipped 
to and from market three or four times before killed. 
These markets are the stockyards where packing 
houses are located. The large packing houses will 
buy at all times cattle of any age or weight, whether 
young calves for veal or old ("canner") cows and 
("bologna") bulls. The prices offered fluctuate 
constantly, but a man who wants to sell is sure 
when he ships cattle to the stockyards that he will 
find a buyer. Nor are the packing houses the only 
buyers at the stockyards. A farmer or cattle man 
who wants a certain number of a certain kind of 
cattle goes in person or instructs a commission firm 
in whom he has confidence to buy them for him 
on the market. It not infrequently happens thati 
he will buy and ship back home cattle which were 
sent in from his own neighborhood. One man may 
bring in steers which he thinks are thoroughly fat. 
Another man sees them and believes that by 
judicious feeding he can put more weight on them 



78 LOANS AND INVESTMENTS 

in a short time, and profit by a fancier price as 
well as the added number of pounds. There are 
speculators there, too, ready to buy nearly any- 
thing on which they have a chance to make money. 
Scattered animals of quality unlike others in the 
same lot, when brought into a bunch similar to 
themselves, sell to better advantage. Shipments 
received late in the day may sometimes be bought 
cheap enough to pay to carry them over night and 
leave the speculator a profit. The market price 
is affected by the number of cattle offered for sale. 
This in turn is affected by the time of year and 
by the season's weather conditions. Drought re- 
sulting in lack of stock water, dried up pastures, 
and short feed crops, will send cattle to market; 
a favorable season will keep them away longer. 
Conditions which are only local do not make 
much difference in the price, as the market re- 
flects the average for the whole tributary terri- 
tory, but the general crop situation has quite an 
influence. Cattle have gradually gone higher in 
price for several years. Meanwhile most of the 
largest ranches have been broken up, some into 
smaller pastures, some partly put to agricultural 
purposes. The class of cattle, notably in Texas, 
has improved so greatly as to fully equal those in 
older States. Farther north the agricultural col- 
leges have taught that balanced rations will reduce 
the time and cost for fattening. It must be con- 
sidered that in every step of handling cattle, breed- 



LOANS AND INVESTMENTS 79 

ing, raising, fattening, marketing, there is constant 
change, and that no rules except of the most general 
nature can be laid down as to the practice of loan- 
ing money on them. It takes about four years to 
produce a beef animal ; and while there is a market 
for it all the time, to sell too soon or to hold too 
long means a loss to its owner. Money can be 
loaned for only a few months at a time to complete 
some one of the processes in its production. 

72. DEVELOPMENT OF THE INDUS- 
TRY. — It has not been many years since the 
buffalo roamed the plains of Nebraska, Kansas, 
Oklahoma, Texas, New Mexico and parts of Col- 
orado, Wyoming and Montana. It was an ideal 
place for stock raising and was soon put to that 
use by the white man. The public land was leased 
for almost nothing, or used, as it frequently was, 
without making any payment at all. Gradually 
much of it passed into the hands of a relatively 
small number of men, each of whom controlled 
many thousands of acres. There were no fences, 
and for purposes of identification each owner had 
his mark or "brand," which was burned into the 
hide of each animal with a hot iron. Effective as 
this method is, it did not satisfy the New York 
money lender of a generation ago, who is reputed 
to have said "I would just as soon have a mortgage 
on a school of herring in the Atlantic Ocean as on 
a herd of cattle in Texas." The breeding grounds 
of the buffalo were mostly in the warm climate 



80 LOANS AND INVESTMENTS 

of the South and Southwest and in the spring of 
the year a migration set in northward with the 
growth of the grass. So with the cattle. They 
were bred in the South and Southwest and grad- 
ually drifted north toward the markets through 
the range country as spring and summer advanced. 
When the free ranges were finally fenced into huge 
ranches, the handling of cattle continued much as 
before, except that where conditions were not 
favorable to the breeding of cattle but were better 
adapted to the feeding and completion of them, 
cattle were shipped in from the great southern 
breeding grounds. As the larger ranches were 
divided into smaller ones, specialization became a 
little more advanced, so that shipments and changes 
in ownership were more frequent. With the influx 
of population that required and demanded land 
for farming purposes, there was a conversion into 
farms of those ranches which appeared adapted 
to the purpose. These first farmers were not cattle 
raisers. It seemed foolish to compete with men 
producing cattle so cheaply on the ranches. Many 
failed to farm successfully because of ignorance of 
the soil, climatic conditions, and related natural 
laws which must be followed. Gradually this 
knowledge was acquired and corn and other feed 
became plentiful. Cattle prices were advancing 
and it was seen to be profitable to put a bunch of 
them in the feed lot for fattening in the fall and 
sell them in the spring. Thus the territory be- 



LOANS AND INVESTMENTS 81 

came divided roughly into sections corresponding 
with the steps in the production of the beef animal. 
73. QUARANTINE LINE. — Bred in the 
South, the animals remain there until about a 
year old, then they are moved north into Texasj 
and Oklahoma and some counties in Kansas and 
Colorado, where the winters are a little more 
severe, and when three to four years old they 
are taken into the feeding sections of Kansas, 
Missouri, Nebraska, Iowa, Illinois, etc. In this 
movement northward the quarantine line is 
crossed, where each animal must be "dipped" to 
prevent carrying fever contagion to uninfected 
districts, or else shipped direct to separate "quar- 
antine" pens at the stockyards for killing. The 
purchaser in each northward movement may go 
south and search for such a bunch of cattle as he 
wants, or he may go to a central market where 
there are many sellers. Cattle will be owned on the 
average by four stockmen before sold for killing. 
On any of the trips to market the packer's offer 
may be higher than that of any feeder, and the 
cattle go for beef. Some of the calves will be taken 
when still carrying the milk fat, and fed so as to 
retain this, and reach a size and weight at about a 
year old that enable them to be sold for "baby beef." 
Thus the variations from the schedule given above 
are numerous, and while it persists in the main it 
is quite irregular. The plateaus and valleys of the 
Rocky Mountain and Pacific Coast States produce 



82 LOANS AND INVESTMENTS 

conditions quite similar to those in the Western 
Plains States. 

74. LOANS ON RANCH CATTLE.— It is 
evident that since ranch cattle are handled in rather 
large herds the funds of small local banks are en- 
tirely inadequate to carry the necessary loans. This 
want was at one time largely met by commission 
firms at the markets, who made loans to buyers 
of cattle through them, endorsed the notes and 
sold them wherever they could find buyers. As 
the paper came to be in demand, the firm found, 
it possible to make a brokerage on the loans and 
commissions on the purchase and sale of the cattle- 
Desire to do a large volume of business and some 
unfavorable seasons resulted in failure on the part 
of some firms to protect endorsed paper and 
brought these loans into disrepute. There are good 
firms doing a conservative and profitable business 
now in both commission and brokerage lines, but 
in late years the tendency has been to make them 
separate businesses. Live stock loan companies 
have been incorporated with organizations equipped 
to inspect the cattle mortgaged and all conditions 
which influence the success of the undertaking. 

75. STOCKER LOANS. — A loan on aged 
steers to finance their final fattening is about as 
certain of natural liquidation at maturity as can 
be found. Younger steers are practically always 
in demand in some parts of the country and are 
hardier than cows. Hence natural division of cattle 



LOANS AND INVESTMENTS 83 

loans is into (1) those on steers one year or more 
old and (2) those on stock cattle, consisting of 
breeding cows, heifers, calves and bulls. Loans on 
stock cattle, when made to reliable and capable 
men, are about as certain of ultimate payment as 
any othess, but it is not so certain that payment 
can be forced at maturity without inconvenience 
and possible loss to the borrower. Unfavorable 
seasons, unusual death losses among the calves, a 
bad market, etc., may leave the deal without profit, 
or worse, if immediate sale must be made; but by 
selling some, and perhaps extending the time an- 
other six months or a year, to increase the calf 
profit, the deal may eventually turn out very well. 
Local banks may well make loans of this kind, as 
they know the customers thoroughly, are on the 
ground all the time, and can step in and take the 
cattle if necessary before a serious loss occurs. 
Such loans, with local bank endorsements, are 
readily taken by bank correspondents to an extent 
based largely on their balances. The steer loans 
can be obtained from larger banks or from cattle 
loan companies. The loan companies, however, do 
make loans on stock cattle very frequently, and 
wahen there is a surplus of money and the demand 
for paper is great, buyers take the notes readily. 
On the whole, "cow loans" are not quite so good 
for the distant purchaser and should be kept as 
close at home as possible. 
76. STEER LOANS.— The largest part of the 



84 LOANS AND INVESTMENTS 

paper sold by the loan companies is secured by 

steers. Without forgetting that loans on other 

classes of cattle are handled similarly, a steer loan 

may be considered as typical. In April or May a 

cattleman of experience goes to the loan company 

where he is acquainted and tells them he wants to 

borrow thirty thousand dollars to buy two-year-old 

steers, for which he has sufficient pasture with good 

water to carry them until fall. If he has cash on 

hand for part of the cost price, so much the better, 

but a considerable margin will not be required, and 

sometimes the whole purchase price will be loaned. 

This is because the lender looks at some other 

things in addition to the property to be mortgaged. 

The man himself is the first consideration; his 

record as a successful handler of cattle, and his 

reputation for honesty and industry. There is a 

saying that "the brand on the man is more im^ 

portant than the brand on the steer." The second 

question is, are the cattle worth the money, and of 

such a class as will increase in value through 

natural growth and reasonably insure payment of 

the debt when due? Third, has he made ample 

provision for taking care of the steers during the 

life of the loan? Fourth, what other assets has the 

borrower? As a matter of record and to set these 

points out in detail for consideration, a statement 

will usually be asked for. Items to be found in 

such statements include name, age, legal residence, 

with Section, Township, Range, County, State and 



LOANS AND INVESTMENTS 85 

Post Office; under assets, the personal property, 
giving number of steers one year old, steers two 
years old, steers three years old, steers four years 
old and over, heifers one and two years old, cows, 
calves (with year of birth), bulls, horses, mules, 
sheep, and hogs, the per head and total value ofi 
each class being shown, feed on hand (itemized), 
cash on hand, and other personal property, and also 
real estate, including homestead less exemption 
and other real estate less encumbrance; under 
liabilities, full details of any encumbrance on live 
stock, other borrowed money, amount due relatives 
and other debts; under general information, the 
number of acres and kind of land under lease, the 
rental price, statement as to any judgments or suits 
pending, reference to other persons informed as 
to borrower's financial condition, number of years 
lived at present location, former residence, whether 
surety on anv notes or bonds, etc. 

77. PURCHASE AND DELIVERY. — The 
application having been considered favorably, the 
cattleman arranges his purchase. The delivery of 
the cattle to him, payment therefor to the seller, 
inspection of the cattle by the agent for the loan 
company, execution and delivery of the note and 
mortgage, and filing of same for record in the proper 
place or places, will be as nearly simultaneous as 
possible. In this instance the loan company takes 
six notes of five thousand dollars each, all secured 
by the one mortgage. This is so that one or more 



86 LOANS AND INVESTMENTS 

of the notes may be sold to customers who could 
not carry as much as thirty thousand dollars of any 
one maker's paper. These are called "split loans." 
A few bankers will not buy notes unless all of the 
loan is owned by them, as they believe there is a 
possibility of loss due to the diverse interests, if 
anything goes wrong, and quick action to a single 
purpose is necessary. Other buyers rely on the 
loan company's endorsement and accept "split 
loans" without question. Banks and others seek- 
ing investments write to the loan company for 
paper. The notes are sold them, endorsed by the 
loan company, at a lower interest rate than the 
company charged the borrower. Copies of the 
mortgage and of the maker's statement may or may 
not accompany each note. The loans run about 
six months, being chiefly made in April or May and 
September or October. This is partly because 
banks are unwilling to put their money out for 
longer periods, and partly because these are the 
seasons of change in cattle ownership, when one 
man takes his profit to date and another begins the 
next process in the growing of the animal. When 
the notes come due the loan company must provide 
for their prompt payment to the holders, and this 
whether the cattle are sold and money paid by the 
borrower or not. It must be prepared to carry 
some paper for a short time with its own funds. 
The company will have kept track of the cattle 
during the six months, watching for any unfavor* 



LOANS AND INVESTMENTS 87 

able condition or any dishonesty, and will know 
when they can be sold. If the borrower wants to 
keep them six months longer, the company may 
consent, and so make a new loan on the same cattle 
to the same man. Otherwise they are put on the 
market and enough of the proceeds turned over to 
the loan company to satisfy its claim. If the pro- 
ceeds should be insufficient, the borrower must 
make up the difference in some other way or the 
company loses. 

78. FEEDER LOANS.— The paragraphs just 
preceding refer to cattle in pastures where grass 
is practically the only food they have except per- 
haps some cotton seed cake in bad weather. Men- 
tion has been made of cattle going to the feed lots 
of Kansas, Iowa, Illinois, etc., when they have about 
reached maturity, to be fattened for killing. In 
addition to the Southern bred cattle brought in,, 
there are, of course, many which have been raised 
in small bunches in these central States. Often 
superior individual attention and careful feeding 
matures them at an earlier age than the Texas 
steer. Wherever they have been raised, they may 
be fattened in pastures on grass in the spring and 
summer, but those to be fattened in the feed lots 
through the winter must be fed corn, alfalfa, silage 
or other roughness, and the like. Cows and 
heifers (particularly spayed heifers), are sus- 
ceptible to very profitable feeding of this kind, 
and loans on them for that purpose are freely 



88 LOANS AND INVESTMENTS 

made both by local banks and by loan com- 
panies. But here again the steer loan has a little 
the preference. His superior resisting power in bad 
weather, if nothing else, gives him an advantage, 
according to general opinion. Banks in the feeding 
country are larger and more numerous than in the 
South, and can handle a greater proportion of the 
loans without outside help. The loans are likely 
to be smaller, too, as the cattle will be handled 
in bunches of moderate size. Nevertheless, the 
loan companies do a considerable business with the 
larger borrowers and with those in communities 
where the number of feeders is too great for the 
local bank. Loans by the companies are handled 
in the manner already described. If the borrower 
has plenty of feed and has provided water and 
shelter, the full purchase price is often loaned. 
There are no requests for renewal of this paper, for 
the cattle must go for killing when ready, almost 
regardless of prices. The advantage of certain 
maturity is had, but at the sacrifice of any oppor- 
tunity to work out of a bad situation. Hogs are 
often put in the feed lot to follow the cattle, and 
the profit in feeding is not infrequently in the hogs. 
They are sometimes included in the mortgage on 
the cattle. Fertilizer from the feed lot, when 
spread on the fields, is a most valuable return to 
the farmer, which should not be overlooked in fig- 
uring his earning on a feeding operation. 

79. BUYING CATTLE LOANS.— As already 



LOANS AND INVESTMENTS 89 

mentioned, cattle loans bearing the endorsement 
of local banks, for amounts proportionate to the 
bank's business, are desirable investments by their 
correspondents. Other cattle loans sold to in- 
vestors serve the good purpose of bringing together 
a wholesome industry and unemployed capital. 
Well handled loan companies are profitable to 
all parties. But there are dangers. The surplus 
of money in recent years has made it very easy 
to sell paper. Individual bankers situated where 
they can loan to advantage have sold a great 
deal of paper with their personal endorsement. 
Most of this is undoubtedly good, but tight money, 
and a bad cattle market when it is due, might em- 
barrass the endorsers. Some bankers and others 
have organized loan companies with very small 
capital and used the companies' endorsement in- 
stead of their own. Not that loan companies are 
bad because they are small and good because they 
are big, but the amount of paper endorsed in pro- 
portion to capital must not be overlooked. Careful 
attention must be given to the reputation of the 
management, and to the personnel, financial associ- 
ations and history of the company. Purchasers of 
cattle paper relying on endorsements should not 
fail to familiarize themselves with the business to 
the extent that they will know something at least 
as to the values represented by the cattle security, 
of the practices in their handling, and the general 
conditions prevailing in the locality. 



90 LOANS AND INVESTMENTS 

80. FARMERS' STATEMENTS.— While ag- 
ricultural loans are made in every State in the 
Union, and therefore under a great variety of con- 
ditions, those made on the general credit of the bor- 
rower must be very like all loans which do not 
carry any definite security. When satisfied as to 
character, mental ability and experience, the banker 
will consider the financial condition of the borrower. 
In past years it has not been the rule to require 
statements from farmers. This is perhaps due to 
the fact that the land itself, the improvements, the 
crops and the live stock, have market values which 
can be pretty accurately determined by the banker ; 
and the quantity and quality of his customers' pos- 
sessions are known to him either from personal 
inspection or by information from neighbors. 
Bankers in farming communities have prided them- 
selves on knowing their customers, their families, 
their implements, and even the individual animals 
among their live stock. Such knowledge is mani- 
festly more intimate and accurate than can be had 
of other classes of borrowers. But while assets can 
be determined fairly well, liabilities are not so 
easily discovered or verified. A man of good stand- 
ing may, even without misrepresentation, borrow 
as much from each of several banks as he is war- 
ranted in owing altogether. The Federal Reserve 
banks urge that statements be obtained from bor- 
rowers, and require that statements accompany 
notes for large amounts. The agricultural colleges 



LOANS AND INVESTMENTS 91 

are demonstrating the value of keeping accurate 
records of farm operations, and are distributing 
standard forms for the purpose. These influences 
aid the banker in his purpose to make his credit 
files confirmatory or independent of his memory. 
Farmers for the most part are not accustomed to 
detailed bookkeeping and if blank forms are handed 
to them to be filled out they should not be compli- 
cated. The principal items in most localities would 
be the number of acres and value of land owned, 
mortgage on same, value of town or city property, 
mortgage on same, number of head and value of live 
stock owned, grouped in kinds and ages, mortgage 
on same, cash on hand and in bank, notes and 
accounts receivable, indebtedness to the bank ob- 
taining the statement, and list of other indebted- 
ness not secured by mortgage. 

81. TACT AND CO-OPERATION. — Tact 
must be employed to obtain even such a simple 
statement from a man who has never signed one 
before, and the wise banker will fill in the informa- 
tion while talking it over with the customer; then 
ask him to read it over, see if it is correct, and 
sign it. It may even be best not to require a signa- 
ture the first time, but let the practice of making 
statements gradually become the custom. It is in 
going over such statements from year to year with 
customers that the banker may be most genuinely 
helpful in warning them against financial errors, 
borrowing money to carry grain for a better price 



92 LOANS AND INVESTMENTS 

when they cannot afford to suffer a possible drop in 
price, buying more land than they can work or pay 
for in a reasonable time, buying live stock when 
they haven't sufficient feed to fatten it; in fact, the 
many temptations to enter speculative deals with- 
out being able to absorb a loss. It is here also that 
a banker may discover that his customer needs not 
a short time loan for a particular purpose but a 
more or less permanent loan for operating capital. 
A real estate mortgage loan will relieve the bor- 
rower of frequent renewals, and can be readily sold 
if desired, so that the bank is left in position to loan 
the money to other customers. 

82. AGRICULTURAL PAPER FOR RE- 
DISCOUNT.— When a banker takes paper with 
the intention of selling or rediscounting it, he may 
ask for a more detailed statement, copies of which 
will be sent with the loan. This may be a rather 
formal instrument, setting forth the borrower's 
name, age, legal address, with section, township, 
range, county, State and post office. The assets 
will include the homestead less exemption, other 
real estate less encumbrance, personal property de- 
scribed in detail as to number of yearling steers 
and price per head, number two-year-old steers and 
price per head, number of heifers, one and two years 
old, with price per head, number and price per head 
of cows, calves, bulls, horses, mules, sheep, hogs, 
etc., amount and value of feed on hand, corn, oats, 
alfalfa, other hay, sorghums, silage, other feed, etc., 



LOANS AND INVESTMENTS 93 

cash in bank with name of bank, other grains or 
staples, description and value of all notes and ac- 
counts receivable, and other personal property. The 
liabilities will include encumbrance on live stock 
described in detail, with name of mortgagee, date, 
property covered, due date, rate of interest, etc., 
other borrowed money itemized, amount due rela- 
tions itemized, all other debts itemized. The state- 
ment will contain information about any leases to 
which the borrower is a party, as to judgments or 
suits pending against him, how long he has lived 
at present address, where he formerly lived, names 
and addresses of references, whether he is surety 
on any notes or bonds of other makers. Such 
declaration may even be sworn to before a notary 
public. Such statements are not infrequently re- 
quired from large borrowers even though the loans 
to them are secured by chattel mortgages. A 
strong showing outside of the property covered 
by the mortgage helps the sale of the paper. 

83. IMPORTANCE OF PURPOSE.— When 
satisfied as to the character, ability and financial 
responsibility of the customer, the banker may still 
hesitate before making a loan until he has learned 
what the money is to be used for, and whether pro- 
vision has been made for payment at maturity. It 
is true that in localities where loanable funds in 
banks regularly exceed the demand, notes of good 
makers are renewed regularly with no suggestion 
that they be paid. Just as in loans to merchants 



94 LOANS AND INVESTMENTS 

or manufacturers, these may have grown out of 
short time notes given to cover particular opera- 
tions, but the makers finding it profitable to con- 
tinue using the funds, and the banks being satisfied 
the paper is good, more or less permanent loans 
are the result. It is not contended that this prac- 
tice is necessarily wholly bad, but loans of such 
character should not be allowed to form too great 
a proportion of the bank's investments. Particu- 
larly in a community where the demand for funds 
exceeds the local supply, continuing loans are 
likely to cause careless planning on the part of the 
makers, and to injure the bank by restricting its 
ability to serve the whole community, or to liquidate 
deposits when called on. The normal agricultural 
loan is self-liquidating. Money borrowed to buy 
cattle for fattening or to be used for seed or for 
planting, cultivating, harvesting or marketing 
crops, will be paid when the cattle or the crops are 
ready for sale. Various expense items are naturally 
included, such as cost of feed for work animals, 
wages of employees, family living expenses, imple- 
ments, etc. It is the part of the good banker to 
judge whether the amount he is to furnish is justi- 
fied by the probability of returns from the enter- 
prise and the ability of the borrower to pay if it 
proves unprofitable. Generally speaking, normal 
loans to farmers and live stock men of responsibility 
and experience are ideal from the banking stand- 
point. When, however, cattle or sheep are bought 



LOANS AND INVESTMENTS 95 

with the idea of catching a quick upturn in price, 
or when staples are held for an advance and not 
because of inability to dispose of them rapidly, then 
a loan is no longer a normal one for agricultural 
purposes, but a loan for speculation in agricultural 
products, and should be treated accordingly. 

84. COUNTRY BANKING PROBLEMS.— 
Loans are based in some States almost entirely 
upon the borrower's general assets; that is, a mort- 
gage on personal property is very rarely taken. In 
other sections, chattel mortgages secure nearly 
every loan made by banks. This is particularly 
true in newly settled communities, where the bor- 
rowers have limited means and have not established 
records as to character. The laws affecting chattel 
mortgages differ in the various States as to place 
of riling for record, etc. It is always well to remem- 
ber two things in handling this class of paper. 
Have the wife sign the note and mortgage with 
the husband, whether necessary under the law or 
not, and describe the property in the mortgage so 
accurately and minutely that identification will be 
easy and unmistakable. Loans of this kind usually 
pay a high rate of interest, are for small amounts, 
and are troublesome as well as risky. They furnish 
practically the only means, however, of financing 
people who may later become good depositors. 
Loans to tenants are similar to those just described. 
Bankers who find it possible to keep sufficient funds 
employed otherwise, often refuse to make tenant 



96 LOANS AND INVESTMENTS 

loans. While they admit that tenant farming is 
a growing menace, and that some of them may be 
helped to become landowners by judicious as- 
sistance from a bank, still the risk is something, 
the annoyance is worse, the public criticism on the 
foreclosure of a mortgage is embarassing, and, as 
one man said, "if they are any good, they don't 
remain tenants long." Increasing land values is 
making it harder every year for a man to rise to 
ownership, and the problem of financing such ad- 
vancement should be studied in broad and patriotic 
spirit. Young men, sons of well-to-do parents, who 
begin their independent careers on rented farms, 
and with barely adequate equipment, are entitled 
to a special classification. They may rely on some 
parental assistance if it is absolutely necessary and 
on an inheritance some time in the future. Prefer- 
ring to set up their own households, they undertake 
farming on their own account. If they show 
good judgment in their undertakings, and bear 
favorable reputations, the banker has an oppor- 
tunity to help develop these young men in a busi- 
ness way, and to cement them to his institution by 
making them moderate loans without their fathers' 
endorsement, or other security. 



CHAPTER III 



Stocks and Bonds 

85. OWNERSHIP AND INDEBTEDNESS. 

— The words "stocks" and "bonds" have until re- 
cently been applied indiscriminately to the financial 
obligations of governments. Some of the early 
certificates of indebtedness of the United States 
were known as "stocks," and the same name still 
clings to certain obligations of the city of New 
York. In the language of modern finance, how- 
ever, bonds are certificates of indebtedness and 
stocks are certificates of ownership. In incorpor- 
ated companies bonds represent specific liens on 
property possessed, and stocks represent the prop- 
erty itself. In other words, the owner of stock 
in a company is a part owner of the company, and 
participates in the profits and losses, while an 
owner of bonds issued by the same company is 
interested in the success of the company only in 
so far as the security and punctual payment of such 
bonds, principal and interest, are concerned. The 
bondholder has no part in the operation of the 
company; ordinarily he has no voice in its man- 
agement; in short, he is merely a creditor; while 
the stockholder possesses a definite ownership 
interest in the company in proportion to the amount 
of stock owned by him. The bondholder is not 
responsible for the success or failure of the enter- 

97 



98 LOANS AND INVESTMENTS 

prise, while the stockholder, in addition to the 
privileges which go with his stock, has that re- 
sponsibility and obligation which attaches to 
ownership. 

86. STOCKS AND THEIR CLASSIFICA- 
TION.— When a company or corporation is or- 
ganized, money or other things of tangible value 
which are invested in or contributed to the enter- 
prise by the organizers are known as capital. 
Such capital is evidenced by proportionate shares 
of value denominated capital stock. As a matter 
of convenience this stock is divided into equal 
parts, usually of $100 each, termed "shares of 
stock." The total amount of stock which may be 
issued is fixed by the charter of the corporation. 
To evidence the ownership of these shares, cer- 
tificates of stock are issued to holders in amounts 
equal to the number of shares owned. Thus, a 
stockholder owning $5,000 worth of the capital 
stock will have a certificate or certificates repre- 
senting 50 shares of $100 each. These certificates 
specify the number of shares owned, the par value, 
and certain other facts, as for instance, whether 
the stock is common or preferred, assessable, full- 
paid or not. Generally speaking, there are two 
classes of stock, "common" and "preferred," and 
the usual relation that each bears to the other is 
indicated by their respective names. 

87. COMMON STOCK.— The control or man- 
agement of a corporation, as a general rule, vests 



LOANS AND INVESTMENTS 99 

in the ownership of common stock. Ordinarily the 
possession of a share of common stock entitles the 
registered holder thereof to a vote at recurring 
stated periods for the legally constituted repre- 
sentatives of the stockholders in the management 
of the affairs of the corporation. Such representa- 
tives are usually termed directors, and hold their 
authority by reason of a preference expressed for 
them by the owners of a majority in shares of the 
common stock of the corporation. Directors, when 
elected and during their term of office, have well 
defined rights and powers as to the determination 
of corporate policy and the appointment of execu- 
tive officers, but being compelled at definite times 
to relinquish office, are subject to the owners of 
a majority number of shares of common stock. 
The right of common stockholders to have a voice 
in determining corporate policy usually makes 
common stock more eagerly sought for in open 
market and renders unnecessary the payment of 
large dividends. Ordinarily the amount of divi- 
dends paid upon common stock is less in amount 
than that paid upon preferred stock. In some 
instances, however, common stock dividends ex- 
ceed in amount those of preferred stock. In some 
great corporations, such as the Pennsylvania 
Railroad Company, common is the only class of 
stock issued, while in the Great Northern Railway 
Company preferred alone is outstanding. The 
rights of common stockholders are very minutely 



100 LOANS AND INVESTMENTS 

defined by law and very zealously protected by 
courts. Except where otherwise determined by 
charter or contract provision, the ultimate rights 
of common and preferred stock in a liquidation 
of corporate assets are similar. 

88. PREFERRED STOCK.— Ordinarily pre- 
ferred stock has no voting power, and is therefore 
not of value in determining corporate policy. Pre- 
ferred stock is primarily an investment stock, and 
is issued in such form and with such preferences! 
as to assets and dividends, over common stock, 
as to cause its ready absorption by the purchasing 
public, and thus provide funds for corporate ex- 
tension and development. The rates of dividends 
are usually fixed in amount and unearned divi- 
dends are usually made cumulative. By cumula- 
tive dividends are meant those dividends which, 
if not paid one year, must be paid in some succeed- 
ing year, at the fixed rate provided for, together 
with all dividends which have subsequently ac- 
crued. Oftentimes a minimum rate of dividend 
is fixed with a provision for an increase in propor- 
tion to and in common with the rate of dividend 
declared on an outstanding issue of common stock. 
Preferred stock is usually preferred as to assets 
in corporate liquidation over common stock. In 
case of failure to pay the fixed rate of dividend 
for a stated period of time, the right of holders 
of shares of preferred stock to vote, and of a 
determined number of shares to control corporate 



LOANS AND INVESTMENTS 101 

policy until resumption of dividends, is often ac- 
corded in an indenture providing the terms under 
which the stock is issued. Preferred stock has of 
late years more largely assumed the nature of a 
preferred investment, and sinking funds derived 
from earnings have been created for the redemp- 
tion of preferred stock in definite annual amounts 
at a fixed price or such lower price as may be 
determined by open market purchases. 

89. FULL PAID STOCK.— When a corpora- 
tion has received, either in cash or other value 
permitted by law, the full face of stock, such stock 
is known as "full paid," and that fact is so indi- 
cated on the certificates. If not full paid, the 
holder may be held liable for the unpaid portion, 
unless it is expressly stipulated by agreement that 
the share may be sold for less than its face value 
with the understanding that it may be considered 
full paid. When a corporation has not received 
its full value for stock which has been issued, al- 
ways excepting a reasonable deduction for mar- 
keting expense, such stock is known as "watered 
stock." This term as usually employed applies to 
stock which has been issued in payment for prop- 
erty or services which have been given a value 
in excess of their true worth, or which represent 
expected future value. 

90. TREASURY STOCK.— "Treasury stock" 
is capital stock which has been authorized and 
issued, but instead of being sold or disposed of in 



102 LOANS AND INVESTMENTS 

some other way, is held in the treasury indefinitely ; 
or which, having been outstanding in the hands of 
the public, has been purchased by the company and 
not cancelled. Such stock is an asset of the com- 
pany, but it cannot be represented by a vote in the 
meetings of the company, nor does it ordinarily 
draw dividends. 

91. CERTIFICATES OF STOCK.— A "cer- 
tificate of stock" to be legal must be signed by the 
authorized officials of the company and sealed with 
the corporate seal. It must also specify the number 
of shares represented and must bear the name of 
the registered stockholder. The certificate of stock 
is not capital, but merely the evidence of ownership 
of capital, in the same sense as a deed to a piece of 
land is the evidence of ownership of the land. Stock 
certificates of a corporation are usually kept in the 
custody of a proper official, generally the secretary, 
and bound in a volume with a stub for recording 
each certificate issued. This stub bears the essen- 
tial facts concerning the certificate. If the certifi- 
cate is cancelled it must be returned to the com-4 
pany and is attached to its original stub. Certifi- 
cates of stock may be transferred the same as any 
other evidence of ownership, but the voting power 
of such new stock is not transferred until a record 
of such transfer has been made on the books of the 
company. 

92. VOTING TRUST CERTIFICATES.— In 
the modern development of corporate finance an 



LOANS AND INVESTMENTS 103 

instrument of practical value has come into wide 
use. It is termed the "voting trust." The voting 
trust is an agreement whereby the holders of the 
common or other controlling stock of a corporation 
agree to relinquish for a definite period their rights 
of control in corporate affairs to one or more in- 
dividuals, called voting trustees, who during the 
life of the agreement act for them in the administra- 
tion of corporate affairs, electing directors and per- 
forming the ordinary functions of stockholders. A 
voting trust is usually the corollary of internal dis- 
sension or financial reorganization, and is used to 
insure the restoration of confidence or the protec- 
tion of money advanced to restore the credit stand- 
ing of the corporation involved. Voting trust cer- 
tificates have the attributes of stock certificates 
and are assigned and transferred in similar ways. 
93. SHARES WITHOUT PAR VALUE.— It 
has long been customary to issue stock of a fixed 
par value, usually $100, the same having no rela- 
tion to the intrinsic value of the shares or to their 
selling price. In new companies, stock of fixed par 
value has sometimes been sold at one-tenth of that 
value, such transactions indicating depreciation in 
the value of the stock or the fictitious nature of the 
par value. In the last analysis, a share of stock is a 
certificate of ownership of a specific part of a busi- 
ness. The precise value of such specific part is 
determined by an inventory and a financial state- 
ment. The par value has no bearing upon its actual 



104 LOANS AND INVESTMENTS 

value, except in so far as it represents a fixed unit 
of proportional ownership. The market price of a 
share of stock is dependent, in large measure, upon 
supply and demand, irrespective of the intrinsic 
value disclosed by the corporate books. To actu- 
ally fix the true value of a share of stock and ta 
prevent as far as is possible the issuance of stock 
having a value fictitious, and not intrinsic, confus- 
ing in public service corporations the relation which 
rates and earnings should bear to actual capital 
investment, the certificate of stock having a par 
value has been abandoned in some States and cer- 
tificates bearing proportionate value issued in place 
thereof. Such certificates are accorded a face value 
of the actual original amount paid therefor, values 
being determined by the proportion of value which 
each certificate bears to the actual capital value of 
the corporate enterprise. 

94. MANAGERS' SHARES.— A recent inno- 
vation in corporate finance is the issuance of what 
are termed "managers' shares." Such shares are 
shares set aside by a corporation for purchase by, 
or presentation to, persons who are engaged in the 
active management of the corporation. These 
shares, limited in amount, usually pay a larger divi- 
dend after the regular dividend distribution than 
do the ordinary shares of the company. Thus the 
excess profits are in measure distributed among 
the men who through their efforts created the 
larger earning power of the corporation. In the 



LOANS AND INVESTMENTS 105 

American International Corporation, a recent de- 
velopment in American finance, provision is made 
that if at any time one of the owners of the "man- 
agers' shares" resigns from active management of 
the company, or is dismissed by the directors, he 
must sell his managers' stock to the corporation at 
par or an appraised price, the same to be taken up 
by the man who replaces him in the service of the 
company. 

95. TRANSFER OF STOCKS.— On one side 
of a certificate of stock there is a blank form of 
assignment and power of attorney to transfer, 
which may be filled out by the owner when the 
stock is delivered to another person, with the name 
of such person, or may be signed in blank and de- 
livered. In most States stock so transferred carries 
full legal title, although in a few States registry 
must be made on the books of the company, to 
protect the transferee against the claims of a sub- 
sequent attaching creditor of the transferor who, 
serving a writ of attachment upon the company 
while the stock remains registered in the name of 
the transferor, will acquire superior rights to the 
prior unrecorded transferee. Furthermore, the 
transfer of a certificate of stock is not complete so 
far as the company is concerned until the transfer 
is recorded on the books. Prior to that time the 
transferee would have no voice in the management 
of the affairs of the company and the latter would 
be protected in paying dividends to the former 



106 LOANS AND INVESTMENTS 

owner who would still appear as owner of record. 
A further point to be observed by purchasers or 
lenders of money upon shares of stock is whether 
the stock is subject to any lien of the company for 
indebtedness of the transferor. The laws on this 
subject in the different States vary greatly; in some 
States the company cannot acquire such a lien while 
in other States the company is given a lien or right 
to refuse transfer until the indebtedness of the 
owner of record is satisfied. This right of lien is 
sometimes expressly given by statute and some- 
times created in other ways. The full negotiability 
which attaches to bills and notes does not in all 
cases attach to certificates of stock. For example, 
the New York courts have held that where a stock 
certificate has been signed in blank and lost or 
stolen, the real owner does not lose his title to an 
innocent purchaser from the thief or finder; but 
where there has been unauthorized dealing with 
such a certificate, the innocent purchaser is gener- 
ally protected on the theory of estoppel if the real 
owner's negligence contributed to the misappro- 
priation. 

96. STOCK TRANSFER AGENTS.— With 
the development of large business through corpo- 
rate means, most of the larger corporations find it 
expedient— in fact quite necessary — to appoint a 
"transfer agent," who exercises entire supervision 
of the issue and transfer of their stock; and because 
of the predominance of New York City as a stock 



LOANS AND INVESTMENTS 107 

market, a very large percentage of such agents are 
located in that city. These transfer agents are 
usually banks or trust companies, by whose selec- 
tion the corporation is assured of responsibility, 
reliability and accuracy, all of which are essential. 
Indeed so thoroughly precise must the transfer 
agent be that occasionally he is accused of being 
unnecessarily technical. The reason for the exer- 
cise of such extreme care may be found in the fol- 
lowing extract from the court decision in a recent 
case involving the transfer of securities : "It is the 
duty of such a corporation, before making such a 
transfer, to be satisfied of the genuineness of the 
power presented. In so doing, it must act on its 
own responsibility and incur its own risk of being 
misled by forgery or fraud, and it is no answer to a 
claim put forward by the true owner that the com- 
pany acted in good faith upon what it supposed to 
be genuine authority, and without negligence." 

97. BONDS AND THEIR CLASSIFICA- 
TION. — A bond is a contract between one party 
desiring funds and another party having funds to 
invest. It is a promise by the borrower to pay to 
the lender at a definite future time with interest a 
certain sum of money. The proper classification of 
bonds is difficult owing to their multiplicity and 
the ingenuity displayed in inventing new kinds and 
new names. Bonds may be classified according to 
(1) the character of the obligor, (2) the purpose or 
function of issue, (3) the character of security, 



108 LOANS AND INVESTMENTS 

(4) the conditions of payment of principal and in- 
terest, (5) the evidence of ownership and transfer. 
98. CLASSIFICATION ACCORDING TO 
CHARACTER OF OBLIGOR. — In accordance 
with the character of the obligor bonds are classi- 
fied as "civil bonds" and "corporation bonds." 
"Civil bonds" include Government bonds, National 
and State, and municipal bonds. "Government 
bonds" include United States bonds, bonds of 
United States territories and dependencies, and 
bonds of the various States that constitute the 
nation. "Municipal bonds" include bonds of coun- 
ties, cities, townships, villages, and tax districts. 
"Corporation bonds" are classified as railroad 
bonds, public utility bonds, industrial bonds, timber 
bonds, shipping bonds, and miscellaneous bonds. 
"Railroad bonds" consist of bonds of railroads, 
steam or electric. "Public utility bonds" consist 
of bonds of street railway, gas, electric light and 
power, water, water power, and telephone corpor- 
ations. The terms "industrial," "timber" and 
"shipping" bonds are self-explanatory; "miscel- 
laneous bonds" include corporate reclamation 
bonds, real estate bonds and mining company 
bonds. "United States Government bonds" are 
those issued by the United States Government 
for public purposes. Their purposes of issue are 
naturally broader in scope than either State or 
municipal bonds. Among the various purposes 
for which Government bonds are issued are con- 



LOANS AND INVESTMENTS 109 

struction and maintenance of interstate canals, cost 
of wars, improvements in the Philippine Islands 
and other territories and dependencies, and the 
Panama Canal. Most United States bond issues 
are purchased by bond houses, but occasionally 
there has been a popular bond issue, subscriptions 
to which have been extended to small purchasers. 
There are certain public duties to be performed by 
a State government, such as building highways, 
canals, State schools for various purposes, and 
charitable institutions, all of which may be the sub- 
ject of bond issues, the payment of which may be 
provided by taxation in the same manner as with 
municipal bonds. 

99. CLASSIFICATION ACCORDING TO 
PURPOSE OF ISSUE.— Among the bonds which 
derive their titles from the purpose of issue, are ad- 
justment bonds, income bonds, construction, equip- 
ment trust, extension, improvement, purchase 
money, refunding and terminal bonds. "Adjust- 
ment bonds" are issued to enable a company to ad- 
just its finances or for the purpose of adjusting the 
interests of two or more corporations. "Income 
bonds" are general obligations ranking in lien after 
all specifically secured bonds, the interest on which 
is payable only when earned as income, and in the 
amount determined by the directors. "Construc- 
tion bonds," as their name implies, are for the pur- 
pose of erecting new buildings, or in the case of a 
railroad, new trackage, and as a rule are secured by 



110 LOANS AND INVESTMENTS 

a first mortgage on the property. A progressive 
railroad is under constant necessity of increasing 
its equipment, and therefore "equipment trust 
bonds/' or notes, are issued, and the money thus 
raised is used for this purpose. Such bonds are 
secured by the equipment purchased. "Extension 
bonds" are issued primarily for the purpose of ex- 
tending the main line of a railroad from one point 
to another. "Improvement bonds" are issued for 
the purpose of repairs and improvement on a prop- 
erty. These, in the case of a railroad, may include 
buildings, stations, trackage, rights of way, and 
switch yards. "Purchase money bonds" are those 
which are used as part consideration in the purchase 
of properties. "Refunding bonds" are issued for 
the purpose of procuring funds which shall be used 
in retiring outstanding issues of bonds. Sometimes 
this is done to secure a lower interest rate and 
sometimes in order to take care of maturing obliga- 
tions. "Terminal bonds" are usually issued by 
subsidiary companies organized to hold title to 
terminal stations and properties for one or more 
railroad companies. 

100. CLASSIFICATION ACCORDING TO 
CHARACTER OF SECURITY.— Based on their 
security, bonds are divided into two classes, "unse- 
cured" and "secured." Federal Government, State 
and municipal bonds, while secured by legislative 
lien on tax revenues, are generally termed unse- 
cured bonds. They are unsecured because accom- 



LOANS AND INVESTMENTS 111 

panied by no collateral contract, such as is the case 
with the majority of railroad, public utility and in- 
dustrial bonds. "Secured bonds'" include such as 
have back of them actual value, which may be ob- 
tained by the bondholder through legal action in 
case of default in payment of the bonds. Among 
the various kinds of secured bonds may be men- 
tioned "land grant bonds," the security for which is 
a mortgage on the lands involved ; "real estate rail- 
road bonds,' 5 secured by a mortgage on real prop- 
erty not actually used in the operation of the road ; 
"sinking fund bonds," secured by a fund created by 
a contract which is usually in the hands of a disin- 
terested trustee; collateral trust bonds secured by 
specifically pledged personal property of the bor- 
rower, "prior lien," "first," "second," "third" and 
"general" mortgage bonds, the security for which 
is indicated by their titles. 

101. CLASSIFICATION ACCORDING TO 
CONDITIONS OF PAYMENT.— Bonds which 
are classified in this manner include "gold," "silver," 
"currency," "legal tender," "callable," "convertible" 
and "joint" bonds. "Gold," "silver," "currency" 
and "legal tender" bonds are payable as indicated 
by their titles in the kind of money described. 
Practically all railroad bonds are gold bonds and 
therefore payable in gold. Some Mexican and 
South American bond issues are payable in silver. 
Ohio, Southern, and Western municipal bonds are 
frequently paid in currency or legal tender. "Call- 



112 LOANS AND INVESTMENTS 

able bonds" are those which may be paid before 
maturity at a rate specified in the bond, which is 
usually above the par value. Fully three-quarters 
of outstanding railroad bonds are callable. Union 
Pacific First Lien and Refunding 4s, due in 2008, 
?are callable, for instance, in 1918, at 107^4 and 
interest. "Convertible bonds" are those which 
permit the holder to exchange or convert them 
at a specified rate into other forms of property, 
usually into common stock of the issuing company. 
"Joint bonds" are those whose security for payment 
is the responsibility of two or more corporations. 

102. CLASSIFICATION ACCORDING TO 
OWNERSHIP AND TRANSFER.— Under this 
classification there are three kinds of bonds, "cou- 
pon," "registered" and "registered coupon." "Cou- 
pon bonds" are those which contract for the pay- 
ment of interest by means of separate coupons for 
fixed amounts payable at stated intervals. These 
coupons may be detached and presented for pay- 
ment the same as any promissory note. "Regis- 
tered bonds" are those which are recorded with the 
registrar of the bond issue, and transfer of the title 
to same in order to be legal must be made with such 
registrar. In the case of registered bonds interest 
payments are made only to the registered holders 
or upon their order. "Registered coupon bonds" 
are those the principal of which is registered, the 
coupons being made payable to bearer. 

103. MUNICIPAL BONDS.— Broadly speak- 



LOANS AND INVESTMENTS 113 

ing, any bond issued by the general government or 
any subdivision of the general government, such as 
State, county or city, is a "municipal" bond, but in 
the general acceptation of the term a "municipal" 
bond is one issued by a county, city or town, for 
the purpose of providing funds for public works or 
improvements therein. Such bonds may be issued 
for the erection of a schoolhouse, and be known as 
"school bonds," but must be paid by taxes levied 
upon the people in the municipality or school dis- 
trict issuing the same. Bonds for street improve- 
ment, sewers, waterworks, or drainage, issued by 
a municipality or a subdivision thereof, come under 
the heading of "municipal bonds," and their pay- 
ment is provided for in the same way. In consid- 
ering municipal bonds as an investment, the first 
and fundamental consideration is that of legality. 
It has sometimes happened, even after all legal 
phases of an issue have been carefully scrutinized 
by capable lawyers, that some hidden point has 
been discovered which has invalidated the entire 
issue. Generally speaking, a municipal bond issue, 
in order to be legal, must be in accordance with the 
constitution of the United States and must be auth- 
orized by the constitution and statutes of the State 
in which the municipality is located. Strict compli- 
ance with all terms of statutes is absolutely neces- 
sary. After the legality of a municipal bond issue 
has been established, the investor should assure 
himself that there is a sufficient amount of taxable 



114 LOANS AND INVESTMENTS 

property within the district to insure the payment 
of the interest and principal of the bonds. He should 
satisfy himself also as to the financial record of the 
municipality. The serial municipal bond is gradu- 
ally displacing the long term bond of fixed exist- 
ence, and the sinking fund bond, and is in accord 
with soundest principles of municipal finance. 

104. RAILROAD BONDS.— The railroads are 
the highways of the nation and are absolutely nec- 
essary to its development. The properly issued and 
well secured bonds of well managed and honestly 
financed railroads are premier corporate securities. 
The classifications of railroad securities are most 
numerous, and are the result of methods used in ob- 
taining great sums of money demanded by rapid de- 
velopment. "General mortgage bonds," last in lien 
when originally issued, have become first mort- 
gages on a majority in mileage of main line track, 
and first mortgage bonds may be a lien on a limited 
mileage of secondary trackage. Discrimination 
and careful investigation are essential to safety, and 
the last mortgage on a well established line is often 
better security than a first mortgage on a newer 
road, or one serving an undeveloped territory. Out- 
standing bonds must bear a fixed ratio to mileage, 
and when bonds have been issued at a rate in excess 
of $20,000 per mile, care should be exercised in their 
purchase. The value of bonds, in the last analysis, 
rests upon the earning power of the railroad. Prin- 
cipal and interest can only be met when net earn- 



LOANS AND INVESTMENTS 115 

ings are ample, and railroad credit vanishes in in- 
creasing ratio as net earnings decrease. The total 
annual bond interest charge of a railroad should 
not exceed one-half of the annual net earnings. 
When net earnings are not in proportion of two to 
one to interest charges on outstanding bonds, care 
should be exercised. The interest charges on out- 
standing bonds must be met when due or default 
occurs and foreclosure follows. Such is not the 
case with dividends on capital stock. Dividends are 
payable only when earned and with the consent of 
the board of directors. Dividends are not usually 
fixed charges against earnings. Therefore the well 
financed railroad has a larger amount of outstand- 
ing capital stock than outstanding bonds. Con- 
servative financing is reaching a critical point when 
the proportion of outstanding bonds to capital stock 
exceeds one-half. The railroad is then in a position 
where it is compelled to pay too high a price for its 
money, which, if long continued, weakens its re- 
sources and causes collapse. In estimating the se- 
security of railroad bonds, careful study should be 
made of the territory served by the road, its popu- 
lation, resources and capacity for development, as 
well as of its past history. 

105. PUBLIC UTILITY BONDS. — Public 
utility corporations are now well established, and 
their securities are considered prime investments. 
Recent legislation in the various States has been 
favorable to the stability of public utility enter- 



116 LOANS AND INVESTMENTS 

prises. Public utility commissions insure steady 
earnings and prevent reckless and disastrous com- 
petition. The extension of the use of electricity, 
gas and the telephone, is in its infancy. Public 
utility earnings have shown a steady increase, and 
will undoubtedly continue to do so for some fur- 
ther period of time. Bonds issued by public utility 
companies are approved by public utility commis- 
sions, and in most States can only be issued for the 
actual cost, determined by investigation, of the 
property upon which the bonds are a lien. High 
grade public utility bonds bear a higher rate of 
interest, and usually sell at a lower price, than rail- 
road bonds of equal grade, thus insuring a larger 
interest return. Statistics show that for a period 
of years public utility earnings have exhibited a 
steady increase in volume, irrespective of prosperity 
or depression. Gas, electricity and the telephone 
are no longer luxuries, but necessities, and with in- 
creasing population and cheapness of service, the 
public utility corporation is benefitting. Electric 
street and interurban railroads, though carriers of 
passengers and freight, are usually termed public 
utility corporations. Their condition is not as a 
rule as favorable as that of other public utilities, on 
account of the greater expense entailed in carrying 
on their functions, and because they are in most 
cases subject to the legislative action of common 
councils in cities, regarding terms of franchise and 
regulation of service. In some States, however, the 



LOANS AND INVESTMENTS 117 

indeterminate franchise, practically eliminating 
competition and placing rate making under the 
control of a State public utility commission, has 
displaced the franchise, to the benefit of the cor- 
poration. The investment restrictions applying to 
the bonds of public utility corporations as to se- 
curity, proportion of net earnings to interest 
charges, ratio of capital stock to bonded debt, out- 
standing bonds per mile in the case of railways, 
territory and population served, are similar to those 
applying to steam railroads. It should be noted, 
however, that most public utility corporations oper- 
ate under a franchise limited as to time, and care 
should be taken to ascertain that the franchise does 
not expire during the life of the outstanding bonds. 
106. INDUSTRIAL BONDS.— With the great 
development of industrial corporations insuring, as 
such growth does, enlarging fields for the sale of 
goods and their manufacture at lowest cost, the 
command of inventive genius to overcome the ad- 
vantages gained by the inventions of others, the 
control of the production of raw materials, and 
diversity of output, the financing of their credit 
needs by bond issues has become recognized as a 
conservative method of finance. Industrial corpo- 
rations always contend, however, with different 
problems than do most other forms of enterprise, 
and in a large measure their business, although a 
fundamental one, sometimes involves risks ap- 
proaching the classification of hazardous. Bond 



118 LOANS AND INVESTMENTS 

issues of such type are to receive different consid- 
eration than others. Good will and patent rights 
must be carefully considered. A going plant may 
have large cash value, but the salvage worth of such 
a plant is small. If the management is not pro- 
gressive, competition may soon eliminate its goods 
from the market. The supply of raw materials 
must not be entirely dependent upon the good will 
of others, nor must it be so far removed from the 
place of manufacture as to work a disadvantage in 
competition. The quick assets of the corporation 
must be carefully investigated and analyzed, and 
the proportion of net quick assets to outstanding 
bonds should be a fixed one, and always maintained. 
Industrial bonds should mature at an early period, 
and should have a sinking fund provision, or pre- 
ferably should be serial in maturity. The propor- 
tion of net earnings to interest charges should be 
larger than in the case of railroads and public utility 
corporations, on account of the rapid changes which 
take place in business conditions. A first mortgage 
bond of the United States Steel Corporation is un- 
doubtedly good, but it cannot be placed in a similar 
class or be used for similar investment purposes, as 
the first mortgage bond of the Pennsylvania Rail- 
road Company. 

107. EQUIPMENT BONDS.— By reason of an 
unusual record of stability and safety, continuously 
extending over a long period of years, "equipment 
bonds" or "car trusts" deserve consideration as in- 



LOANS AND INVESTMENTS 119 

vestments of the highest type. Equipment bonds 
issued upon the security of rolling stock, including 
locomotives, are in large measure preferred liens 
upon the income of the issuing corporation, for a 
continuance of earnings depends upon the use of 
rolling stock, and a default in equipment bonds 
would deprive the corporation of its chief means of 
revenue. In times of receivership, courts have or- 
dered the payment of interest and principal due 
upon equipment bonds, in preference to other obli- 
gations, and for a long period of years there has 
been no default in equipment obligations. Equip- 
ment bonds or notes are issued under what is legally 
a lease or an agreement of conditional sale. These 
agreements are usually recorded in the States in 
which the corporation operates, and are not can- 
celled until payment in accordance with their terms 
is fully made. The Philadelphia plan of equipment 
trust provides for the creation of an equipment 
trust by agreement between a trust company, ond 
or more designated individuals, and the corpora^ 
tion. The equipment is purchased by the equip- 
ment trust and leased by the trustee to the corpora- 
tion, at a rental sufficient in amount to meet the 
principal and interest of the equipment bonds or 
notes when due. Such bonds or notes are guaran- 
teed by the corporation. 

108. TIMBER BONDS.— The issuance of "tim- 
ber bonds" is a comparatively recent development 
in finance. A great amount of these bonds in par 



120 LOANS AND INVESTMENTS 

value has been absorbed by banks and the investing 
public. Timber, standing, and of good quality, is 
an asset which as time passes will increase in value. 
Timber as security for a bond issue has been likened 
to land. The analogy is not a correct one. A part 
is never equal to the whole. Land is a fundamental 
value. Timber is not. Standing timber is ordi- 
narily not insurable. The fire hazard is therefore 
of first importance. Timber bonds have usually 
been issued for a fixed period of time of long dura- 
tion. Provision has been made for a sinking fund 
of a certain percentage in money of the amount in 
feet of timber cut. Failure to provide this sinking 
fund is a default in the provisions of the mortgage. 
To prevent such default timber has been cut when 
the market was so low in price as to cause inevitable 
loss. Such loss exhausted the resources of the com- 
pany obligated on the bonds, and in some cases re- 
sulted in receivership. The sinking fund in timber 
bond issues is not sound, and should be displaced 
by the serial bond issue. The timber business is 
not a stable one, and timber bonds are oftentimes 
classed as hazardous investments. The rate of in- 
terest paid on such bonds would seem to indicate 
that they are so considered. In many timber bond 
issues the security of the issue consists largely of 
other assets than standing timber, such as saw 
mills, pulp mills and paper mills. The bonds may 
also bear an endorsement worth considerably in 
excess of the debt guaranteed. 



LOANS AND INVESTMENTS 121 

109. DRAINAGE AND RECLAMATION 
BONDS. — For the purpose of reclaiming fertile 
land a large part of the time under water, political 
subdivisions designated as "drainage districts" have 
been created under constitutional authority, with 
power to issue bonds and to assess and levy taxes 
against real property for their payment, together 
with the interest thereon accrued. Various methods 
are used in carrying out this purpose and in provid- 
ing for tax levies. In some districts taxes are levied 
by county authorities, in others by judicial officers. 
This type of bond often is little more than a special 
assessment bond against benefitted property, and 
its ultimate payment is secured by the value of the 
property, and not by a general tax levy. "Reclam- 
ation bonds" are similar in purpose and form, and 
are issued for the redemption of arid lands, through 
the use of water. Where municipal districts are 
created for this purpose they are similar to drainage 
districts in form and powers granted. Corporations 
have endeavored to reclaim arid lands through 
funds provided by bond issues, but the problems 
involved have been so intricate and vast that 
disaster in most instances has been the result. 

110. LAND MORTGAGE BONDS.— A type 
of bond which will ultimately become more gener- 
ally utilized is the "land mortgage bond" issued by 
land banks under State authority, or by the various 
associations created under the Rural Credits Act. 
The distinctive features of these classes of bonds are 



122 LOANS AND INVESTMENTS 

long existence before maturity, amortization plan 
of repayment, exemption from taxation, and legal 
investment for fiduciary and trust funds. 

111. BOND ISSUANCE.— Bonds have been 
described as a species of promissory note, being 
a promise to pay a certain sum at a definite time 
with interest at a fixed rate. The main distinc- 
tions between bonds and promissory notes have 
to do largely with proportions. The maker of a 
promissory note, the promisor, may be an indi- 
vidual, a partnership or at times a corporation. 
The maker of a bond, or the obligor, is a govern- 
ment, a State or municipality, or a corporation; 
seldom an individual. The amount of the promis- 
sory note, limited largely by the loaning capacity 
of a bank, is usually less than one hundred thou- 
sand dollars. The amount of a bond issue is 
usually a matter of millions, split up into segments 
that it may be absorbed by the investing public. 
The promissory note is for a period of months, 
the bond is due after a period of decades. It will 
be of interest to trace briefly the process in finance 
through which bonds are issued, taking for an 
example the bonds of a large corporation making 
steel rails. 

112. PROCEDURE IN ISSUING BONDS.— 
There would probably be three or four plants of 
such a company in operation, each located con- 
veniently near its supply of fuel and raw products. 
In the course of time, owing to the development 



LOANS AND INVESTMENTS 123 

of a certain section of the country, conditions 
might arise that would put the business of one 
of these plants on a much more profitable basis if 
it could increase its share of the output, a result 
only to be attained through the erection of several 
new buildings and the installation of costly ma- 
chinery. To do this would require at least $2,500,- 
000. The company, therefore, decides to issue that 
amount in bonds secured by a first mortgage on 
another part of the property. A special meeting 
of the stockholders is held and the whole matter 
is laid before them. A large majority of the stock- 
holders, having full confidence in the officers of 
the corporation, will, of course, send their proxies, 
so that the meeting, perhaps, will be but little 
larger than an ordinary directors' meeting. At 
that time it is decided how long the bonds shall 
run, what the rate ought to be, and what particular 
part of the property shall be mortgaged as se- 
curity for the issue. It will be shown that although 
the interest on the new bonds will add to the fixed 
expenses, yet the increased manufacturing facili- 
ties will largely add to the profits and perhaps 
reduce very materially the amount of money which 
must be borrowed from time to time on short- 
term notes. 

113. BOND UNDERWRITING SYNDI- 
CATES. — The next step is to find a banking 
house that will offer the best price for the entire 
issue, that is, advance the money to the corpora- 



124 LOANS AND INVESTMENTS 

tion, or "underwrite" the bonds. A price is finally 
agreed upon and the bankers take over the issue, 
say at 90 ; that is, they advance to the corporation 
$2,250,000. In the meantime, a trust company has 
agreed to act as trustee of the mortgage securing 
the bonds, receiving a fee in payment for the ser- 
vice, and also probably being appointed as a deposi- 
tory for the payment of the interest on the bonds 
as it falls due. A registrar will also have been 
appointed. 

114. BOND SELLING SYNDICATES.— 
Having received the issue of bonds and advanced 
the money to the corporation, the banking house 
will now undertake to dispose of them at a fair 
profit, not, however, directly to the public. A syn- 
dicate will be formed among several banking and 
bond houses, each of which will take an allotment 
at a certain price. These, in turn, act as distrib- 
uting agents and through their salesmen and letters 
to regular clients the issue is finally taken up by the 
public. In buying the bonds, the ultimate pur- 
chasers are largely influenced by the reputation of 
the banking firm, since the bank's position is in 
the nature of an intermediary between the corpora- 
tion and the public. The net result is that the 
corporation has borrowed from the general public 
in small lots the sum of money needed for its 
purposes. 

115. STOCK EXCHANGES. — Many of the 
larger cities in all countries have found it necessary 



LOANS AND INVESTMENTS 125 

to organize stock exchanges for the purpose of 
facilitating the buying and selling of the enormous 
quantity of corporate stocks and bonds which now 
exist. These exchanges are but the evolution of 
a common meeting place, such as the old coffee 
houses, bank corridors, or certain street corners, 
where it originally was the custom of those who 
dealt in government or other securities to congre- 
gate. A survivor of the old stock exchange locali- 
ties is the modern "curb market" where are sold, 
in the open air, those stocks and bonds which have 
not been listed on any regular exchange. The curb 
market in New York City, which has been in exist- 
ence for more than thirty years, is probably the 
most important one of its kind in the United States. 
Its operations are conducted in Broad street. 

116. SERVICE OF STOCK EXCHANGES.— 
The Stock Exchange gives to good stocks and 
bonds a ready market and a known price. Without 
these two features, bonds would lose their value 
entirely as a temporary investment for the idle 
funds of a bank. It is the ease with which they 
may be converted into cash that makes bonds use- 
ful as "secondary reserve." Stock Exchange prices 
go over the "ticker" and are published in the news- 
papers in every town of importance in the world. 
Thus it is possible to keep in touch with the market 
value of securities far from the centres in which 
they are dealt, and the radius of their usefulness as 
collateral for bank loans is greatly widened. Since 



126 LOANS AND INVESTMENTS 

stocks in financial institutions are not as a rule 
traded in very generally on any of the great stock 
exchanges, this class of stocks does not figure as 
prominently in the daily quotations as do railroads 
and industrials. Nevertheless, the total of bank 
stocks in the United States compares very favor- 
ably with the totals of the other kinds. And in 
spite of the fact that the personal element enters 
into a consideration of bank stocks probably more 
than in any other, it must be admitted that, judged 
by the ordinary elements of strength, these are 
quite as attractive as any other kind. The ease 
which the Stock Exchange affords for the purchase 
and sale of securities which, on account of economic 
causes, are subject to fluctuations, has made it a 
centre for speculation as well as investment. Au- 
thorities find it hard to agree as to what extent 
these two terms may or may not be synonymous. 
117. GOVERNMENT OF STOCK EX- 
CHANGES.— The government of the Exchange 
is vested in a committee, consisting of a president 
and other officers, together with a number of mem- 
bers. This governing committee has power to 
draft rules for the conduct of business and is the 
administrative body. In addition, there may be 
several other committees, for example the commit- 
tee on stock list, which, after investigation along 
prescribed lines, has authority to list stocks on the 
Exchange. The members of the Exchange have 
"seats," which term means the privilege to con- 



LOANS AND INVESTMENTS 127 

duct business on the "floor." This is the large 
open space where the brokers congregate. At in- 
tervals are posts which designate the particular 
stock which may be bought or sold there. This 
system is one of wheels within a wheel and makes 
it unnecessary for a broker to search about the 
room for a purchaser when he wishes to sell or buy 
a certain stock. Sales are made practically at auc- 
tion; that is, the seller asking for a price and the 
buyers bidding usually a little below. As sales are 
effected, memorandum notes are made by both 
parties, which are checked up at the end of the 
day. In the larger stock exchanges, settlement is 
made through the stock exchange clearing house 
for the more active stocks. This mechanism oper- 
ates similarly to the ordinary bank clearing house 
for the exchange of checks. Well-known active 
stocks are usually listed on several stock exchanges 
and this fact has led to what is known as the "arbi- 
trage" business, that is, the purchase of stocks in 
one city, London, for example, where for some local 
reason prices may be low, the stocks being then 
resold at a higher price in New York. 

118. FINANCIAL TERMS.— There are many 
terms common to stock exchanges, a few of which, 
although in everyday use, are not generally under- 
stood by the public. Such are the following: 

"Bear" — One who is interested in having the 
prices of one or more securities decline. 

"Bull" — One who wants prices to advance. 



128 LOANS AND INVESTMENTS 

When a broker has bought more of a certain 
stock than he has contracts to deliver, he is said 
to be "long" of that stock. Selling "short" means 
selling, or contracting to deliver, stock that the 
broker does not own. A "short interest" is a group 
that expects to buy stocks after a fall in prices. 
If instead prices have advances, such brokers incur 
a loss. 

Another expression in common use, but not 
clearly understood, is the term "watered stock." 
Such stock is, of course, in disrepute, and means 
that a larger issue of stock has been sold to in- 
vestors than is represented by the actual value of 
corporate property. This is not to be confused 
with over-capitalization, which means a larger 
capital has been subscribed than is necessary to 
conduct the business on an interest or dividend 
paying basis. 

119. BANKS AND STOCK EXCHANGES.— 
For the purpose of buying and selling stocks and 
bonds, the broker requires a vast amount of money, 
since the purchaser may not settle until the securi- 
ties are actually delivered or transferred. This 
money is advanced by the banks on collateral by! 
what is known as "call" or "demand" loans. The 
bank is privileged to ask payment for such loans 
on short notice, although custom has decreed that 
a sufficient time must be given the borrower to 
make a readjustment. Demand loans sometimes 
run for long periods of time, the interest being 



LOANS AND INVESTMENTS 129 

paid at certain intervals at varying rates. While 
the call money market may be said to bring the 
banks in closer touch with the speculative element 
of the stock exchange than may be best, yet is un- 
doubtedly an excellent medium through which the 
inflexibility of reserve requirements may be ad- 
justed. For example, a large part of the surplus 
funds of all the banks in the United States has a 
tendency to gravitate to New York. It is the stock 
market which creates a demand for this money 
and it is mostly all absorbed by the brokers on 
call loans. 

120. BONDS AS INVESTMENTS.— As has 
been stated, many banks now conduct a separate 
department, the function of which is to pro- 
vide proper facilities and advice for their customers 
in the purchase of bonds. Such departments are 
under the supervision of experts who are specialists 
on bond issues and values. The average investor 
has neither the capacity, experience nor time fori 
study to enable him to make a wise choice in the 
purchase of bonds. Against fake investment 
schemes and wild cat bond issues, State laws have 
been proposed, such as the pioneer "blue sky law" 
of Kansas. This law requires every investment 
company, whether organized under the laws of the 
State of Kansas or any other State, to file in the 
office of the State Bank Commissioner a statement 
showing in full detail the plan upon which it pro- 
poses to transact business, a copy of all contracts, 



130 LOANS AND INVESTMENTS 

bonds or other investments which it proposes to 
make with or sell to its contributors, also a state- 
ment showing the name and location of the invest- 
ment company, and an itemized account of its 
actual financial condition, with the amount of its 
property and the amount of its liabilities, and such 
other information as may be required. If condi- 
tions are found to be satisfactory, the Bank Com- 
missioner, in whom complete judicial authority 
rests, will then issue a license for the vending com- 
pany and its agents to do business in the State. 
Certain institutions and certain securities are ex- 
empt from the provisions of the statute, viz. : State 
and National banks, trust companies, real estate 
mortgage companies dealing in real estate mort- 
gage notes, building and loan associations, and cor- 
porations not organized for profit. The securities 
excepted are bonds of the United States, State of 
Kansas, or some municipality of the State of Kan- 
sas, and notes secured by mortgage on property in 
the State of Kansas. The interests of the pro- 
spective investor are thus safeguarded by expert 
advice and legislative statute. 

121. ELEMENTS OF SECURITY.— The ele- 
ments of security in stocks and bonds have been 
tersely formulated by Rufus Waples of Philadel- 
phia in the following rules: 

(1) Minimum liability of loss is secured in the 
class of bonds authorized for the investment of 
trust funds by such a State as New York. 



LOANS AND INVESTMENTS 131 

(2) No reasonable likelihood of loss is incurred 
in buying bonds that are legally issued and are a, 
valid and binding obligation on all the taxable 
property of a city of over 10,000 population, when 
it is a long settled community and has many di- 
versified sources of revenue, with a debt of about 
5% of the assessed valuation or less. Smaller cities 
are more apt to be negligent at times in paying 
obligations at the date due. 

(3) There is a very strong presumption of 
safety in bonds of dividend paying transportation 
companies enjoying right of eminent domain and 
on those of public utility corporations (railroads, 
street railways, gas, water works, etc.), when satis- 
factory earnings have been maintained for several 
years; when the amount of bonds authorized is 
properly limited; when charter and franchise or 
physical or other conditions offer a large measure 
of protection from competition; and when the 
franchise will survive the maturity of the bonds 
for a satisfactory period. 

(4) There is a fair presumption that interest 
on an industrial bond will be earned and bond paid 
at maturity, if the permanent, available assets (land 
and buildings of a general character and property 
that cannot be diverted or seriously depreciated) 
offer foreclosure value sufficiently in excess both of 
the bond issue and of all practicable depreciation, 
and if the surplus earnings provide an adequate 
sinking fund for the retirement of bonds. 



132 LOANS AND INVESTMENTS 

(5) The probabilities strongly favor regular 
dividends on a conservative issue o£ preferred stock 
when a much larger issue of common stock has 
long earned dividends and surplus, and when com- 
mercial fluctuations cannot seriously unsettle the 
average net business profit. 

(6) There is a good business chance that com- 
mon stock will maintain the average earnings of 
the past ten years if the business is essentially of 
a permanent nature ; and if the managers who built 
up the business are in the prime of life, and have 
accumulated large resources as surplus earnings of 
said business; and if they retain both the active 
management and their own interest in the business. 

122. TEST QUESTIONS.— An investor, when 
offered full information about a security that is 
new to him, and that does not at once command 
his confidence, wishing to know the favorable 
features, and to discover the points of danger, can, 
with a little patience, act understanding^ by apply- 
ing certain well-established principles, taught by 
the history of securities, and conveniently made 
use of as test questions. 

(1) Was the bond prepared by the best legal 
talent, at the instance of experienced bankers, with 
the single purpose of affording the greatest protec- 
tion possible to the bondholders? 

(2) Were all steps taken under honest, capable 
experts (business, legal, engineering and account- 
ing), and are the records available for examination? 



LOANS AND INVESTMENTS 133 

(3) Is the capitalization conservative? Has the 
cash cost or probable physical and franchise value 
been closely approached or exceeded in the author- 
ized bond issue? 

(4) Is the security issued by a company that 
furnishes all reasonable information to stock- 
holders about its earnings and condition? 

(5) If the security is issued by a company that 
should prosper greatly by increasing population, is 
the company's property so situated that local 
growth in any portion of its territory will benefit it? 

(6) Are the bonds and stock owned in good 
part by men of financial strength whose self-interest 
would lead them at all times to consider the welfare 
of the company? 

(7) If foreclosure became necessary, would a 
creditor or bondholder be satisfied to become part 
proprietor or property owner, on account of the 
great value of the pledged property? 

(8) Has the management ably, conservatively 
and conscientiously worked out developments for 
the good of the company? 

(9) Are the employees contented, amenable to 
discipline and working harmoniously with the 
management? 

(10) Has the earning power back of this se- 
curity a broad dependence upon the patronage of 
many customers well able to pay for service or 
goods? 

(11) Is the earning power of the company 



134 LOANS AND INVESTMENTS 

fairly well protected from injurious competition 
and likely to continue so, with a growing popula- 
tion to serve or trade to rely upon? 

(12) Is the earning power of the company de- 
pendent upon the patronage of hoped-for cus- 
tomers, or upon sub-companies organized to supply 
a demand? Does it seem likely that profits are 
only a future matter — to be reached in "process 
of time." 

(13) Does the earning power depend upon any 
expectation of unfair advantage over competitors, 
such as reliance on a degree of official favoritism 
that seems attractive to some men, though it 
cannot permanently aid a true investment bond or 
stock? 

(14) Are the conditions of earning power grow- 
ing unfavorable from (a) Insufficient capital? 
(b) Increasing cost of operation? (c) Increasing 
demands of employees, or strikes? (d) Substitu- 
tion by competitors of new methods or materials 
for old? (e) Depletion of products of mines or 
quarries? (f) Depletion of products of forests? 
(g) Depletion of products of agriculture? (h) Loss 
of population? (i) Increasing cost of service or 
distance of deliveries? (j) Increasing cost of se- 
curing raw materials or fuel? (k) Obsolete equip- 
ment or superior equipment of business competi- 
tors? (1) Loss of tariff advantage? (m) Loss of 
skill or prestige in management? (n) New or im- 
proved or shorter competing railway lines? (o) 



LOANS AND INVESTMENTS 135 

Larger tonnage in competing steamship lines? (p) 
New rival methods of doing business? 

(15) Is the price asked for the bond or stock 
much greater or less than the usual quotation? 

(16) Has the security been quoted higher or 
lower in price because of some influence afterward 
withdrawn? (Learn if there have been purchases 
by a sinking fund, expectation that the issue would 
be bought in and retired, accumulation in view of 
acquiring voting control, or supposed important 
advantage or disadvantage from new connections, 
discoveries, trade expansion or loss, etc., and learn 
exact facts.) 

(17) Is the bond offered presented as a bar- 
gain, at such a price, or with such prospects of 
peculiar advantage to buyer as to disorganize the 
investor's critical faculty and hasten him into a 
purchase in the belief that he is securing great 
value for much less than it is worth? 

(18) Are the bond buyer and his associates fur- 
nishing money for experiments to get 5% if a new 
enterprise prospers and take all the loss if it fails? 

(19) Is the bond issue large enough to secure 
the best legal talent, if it should be needed to pro- 
tect the issue, by levying a small percentage upon 
each bond? 

(20) Are the business affairs of the company 
conducted on such a scale that a judgment for 
injury or loss of life would probably be but a small 
percentage of the net earnings of the company? 



136 LOANS AND INVESTMENTS 

(21) Is the bond issue so large, or complicated, 
or difficult to understand, that sales of timid 
holders would be likely to cause great price fluctu- 
ations ? 

(22) Is the vendor of the security able, in behalf 
of the bond or stock offered, to give satisfactory 
replies to all questions above cited that properly 
apply to it? 

(23) Is the vendor, through responsibility and 
ample experience, an authority for all statements 
made by him? 

(24) Have responsible bankers directed the 
initial and all later steps taken in preparation of this 
security, bringing an experienced, judicial, business 
training to bear upon the fullest information, ob- 
tained by the most capable experts available? 



CHAPTER IV 



Collateral Loans 

123. PLEDGE OR HYPOTHECATION.— 

"Collateral loans" are loans secured by pledge o£ 
personal property. A pledge is a bailment of per- 
sonal property as security for the payment of a 
debt or the performance of an act, with an option 
of sale in the pledgee upon the default of the 
pledgor in his engagement. The article pledged 
may be any species of personal property, but of late 
years a pledging of stocks, bonds, negotiable paper 
and other representatives of intangible personal 
property has come to be designated by the term 
"hypothecation," or the giving of "collateral se- 
curity," to distinguish such a pledge from a pledge 
of material articles. A pledge gives greater rights 
than a lien, for a pledgee has a power of sale which 
the owner of a lien has not. It is less than a chattel 
mortgage, for in a chattel mortgage the legal title 
passes, subject to be divested upon the fulfillment 
of the mortgage terms ; in a pledge the title may or 
may not pass— ordinarily it does not, but it has 
been held that it does in collateral securities. It 
differs further from a chattel mortgage in that to 
create a pledge no writing that it is a debt and a 
surrender of possession of property is necessary, 
and it is required merely that there be property as 
security. Ordinarily, too, a chattel mortgage must 

137 



138 LOANS AND INVESTMENTS 

be recorded to be effective against third parties, 
while a pledge need not be. 

124. FORMATION BY CONTRACT. — A 
pledge is created by contract, either express or 
implied. An assignment of securities by a debtor 
to a creditor is presumed to be a pledge rather than 
a payment, and where doubt exists whether the 
transaction is a pledge or a chattel mortgage the 
courts favor holding it a pledge. The aim is to 
determine the real intention of the parties, and 
classify the transaction according to the intention 
shown. There must be a debt or engagement to 
be secured in order to create a pledge, but this debt 
may be some other person's than the pledgor's, 
and a pledge may be made to secure a present, 
future or past debt, though to make a valid pledge 
for a past debt some new consideration is ordin- 
arily required. The pledge may be made to cover 
new debts as they arise, but there must be an 
agreement between the parties to effect this, for 
the pledge will not be deemed to attach to the new 
debt unless the new loan was made upon the se- 
curity of the pledge. So the existence of a former 
debt gives the pledgee no right to hold the pledge 
when the debt to secure which it was given has 
been paid. If the debt or contract to secure which 
the pledge is given is illegal, the pledgee can- 
not of course recover upon the contract, but he 
may nevertheless retain the pledge until it is 
redeemed. 



LOANS AND INVESTMENTS 139 

125. WHAT MAY BE PLEDGED. — Prac- 
tically any personal property, tangible or intangi- 
ble, may be pledged, as the right to shares of stock 
in a corporation. Even property exempt from exe- 
cution on a judgment, as a mechanic's tools, or 
necessaries, may be pledged. Property not yet in 
existence cannot be pledged, and the attempt to do 
so merely creates a contract to make a pledge in 
the future, like an agreement to sell. Pay of soldiers 
and pensions cannot be pledged. By the National 
Bank Act it is provided that "No association shall 
make any loan or discount on the security of the 
shares of its own capital stock, nor be the purchaser 
or holder of any such shares, unless such security 
or purchase shall be necessary to prevent loss upon 
a debt previously contracted in good faith, and 
stock so purchased or acquired, shall, within six 
months from the time of its purchase, be sold or 
disposed of at public or private sale." 

126. PARTIES AND TITLE.— A person who 
transfers personal property in pledge as security 
for a debt must own the property or at least have 
apparent authority to pledge it. One who has been 
voluntarily clothed by the owner with the indicia 
of ownership, though this may have been induced 
by fraudulent representation, may make a valid 
pledge as against the owner. One who takes nego- 
tiable instruments in pledge before maturity in good 
faith for value and without notice of any defect 
in the pledgor's title, acquires a valid holding title. 



140 LOANS AND INVESTMENTS 

Except in these two cases the pledgee acquires no 
greater title than the pledgor had. Mere possession 
of chattels, by whatever means acquired, if there 
be no other evidence of property or authority to 
sell from the true owner, will not enable the pos- 
sessor to give good title. An agent may pledge 
when and as his principal holds him out as having 
authority; if an agent pledges goods of his prin- 
cipal to secure his private debt, the principal is 
entitled to recover them from the person to whom 
they are pledged, unless the agent was invested with 
the indicia of ownership, or the pledge was of ne- 
gotiable securities. In most States, by statute en- 
actment, factors (commission merchants) may 
pledge goods entrusted to them to sell. One mem- 
ber of a partnership may make a valid pledge of 
firm property to secure a partnership debt, but not 
to secure an individual debt. An executor, admin- 
istrator, trustee or other person in a representative 
capacity may not pledge his trust property for his 
own benefit. One who has only a lien cannot make 
a valid pledge, because to maintain a lien he must 
retain possession, while a pledge requires a delivery. 
Buying stocks on a margin creates the relation of 
pledgee and pledgor between the broker and his 
customer. 

127. DELIVERY.— An absolute essential to the 
creation of a pledge is a delivery, actual or construc- 
tive, of the property pledged. A constructive delivery 
occurs when the evidence of recognized symbols of 



LOANS AND INVESTMENTS 141 

the thing is delivered, as the delivery of a ware- 
house receipt, or a bill of lading. But there must 
be some delivery. Thus where a bank cashier, to 
secure a creditor, sealed up a package of bank notes 
with an endorsement of their purpose and placed 
them in the bank vault, it was held that the creditor 
had no pledge or lien. A delivery to a third party 
for the pledgor's benefit with his consent is suf- 
ficient. A delivery with an intention to create a 
pledge is sufficient to create the relation of pledgor 
and pledgee without writing or other act, but not 
in the case of certificates of stock, where a writing 
is required unless the certificate has been endorsed 
in blank. Even where a note is payable to a person's 
order there may be a valid pledge of it without en- 
dorsement, though the practice is not to be recom- 
mended. But in the case of stock it is necessary 
that there be a written transfer or power of attorney 
of some kind. The pledge continues so long as 
the pledgee retains possession, and the pledgee 
has a right against all the world to the retention of 
the article pledged until the payment of the debt 
secured, except as against the holder of a right 
which attached to the property before the making 
of the pledge. But a pledge of collateral securities 
may be temporarily redelivered to the pledgee for 
the purpose of collection by the pledgor without 
affecting the pledgee's lien, though this exception 
is not favored and is strictly limited. 

128. RIGHTS AND LIABILITIES OF 



142 LOANS AND INVESTMENTS 

PLEDGOR. — A pledgor has a right to assign, by 
sale or otherwise, his reversionary interest in the 
pledge, and upon notice to the pledgee the latter 
will be bound upon payment of the debt secured to 
turn the pledge over to the assignee. He has also 
a right to sue any one who injures the pledge, 
though preference is given the pledgee in the matter 
of suing because his interest is generally greater. 
He has, of course, the right to recover the pledge 
on payment of the debt for which it was given as 
security, and he cannot be deprived of this right at 
the time of making the contract. To allow this 
would permit lenders to crush their customers. But 
the pledgor's right to redeem may be released by 
a subsequent contract founded on a new considera- 
tion. Statutes in many States allow a pawnbroker 
to sell the pledge and foreclose the pledgor's right 
to redeem at the expiration of a fixed time, gen- 
erally a year. As to the liabilities of a pledgor, he 
is, of course, liable for the original debt, default in 
paying which may lead to a sale of the pledge and 
and the application of the proceeds to the debt so 
far as they will go. If not sufficient to extinguish 
the debt he still'owes the balance. The pledgor also 
impliedly warrants his title as that of an absolute 
owner. 

129. RIGHTS AND LIABILITIES OF 
PLEDGEE BEFORE DEFAULT.— The pledgee 
gets no better title than the pledgor had, except in 
the case of negotiable instruments, and except 



LOANS AND INVESTMENTS 143 

where the pledgor has been clothed by the owner 
with the indicia of ownership. The best example 
of clothing one with the indicia of ownership occurs 
in pledges of certificates of stock. These are not 
regarded as negotiable instruments, but the owner, 
by endorsing or signing the power of attorney to 
transfer, thereby invests the holder with the ap- 
parent ownership, and the latter may then pass a 
good title to one who buys for value without notice, 
in good faith. There are some limitations to this, 
as where the pledgor is known to be an agent for 
a trustee the pledgee cannot take the stock with 
full protection unless he inquires into the authority 
of the representative to make the pledge. Where 
the owner himself never endorsed the certificate, 
but some one else without authority did, that does 
not avail against the true owner even in the hands 
of a pledgee or transferee without notice for value. 
The owner of an instrument negotiable or non- 
negotiable cannot be precluded by a forgery. The 
pledgee having the right of possession may sue any 
person who causes injury to the pledge, because he 
has generally a greater interest than the owner 
himself in keeping the pledge intact. 

130. RIGHT TO THE USE AND PROFITS 
OF THE PLEDGE.— The pledgee may use the 
pledge so far as is reasonably necessary. Ordin- 
arily this would be little or nothing, but the pledgee 
of a horse would have to use the pledge in order 
to keep it in condition, and in all cases the pledgee 



144 LOANS AND INVESTMENTS 

may use the pledge as the pledgor permits. The 
pledgee may collect the profits or income of the 
pledge, as dividends on stock or interest on bonds, 
but he must apply them to the principal debt, and 
if they exceed the amount needed, he holds the 
excess in trust for the pledgor. The pledgee may 
have pledged stock transferred to his name on the 
books of the company, and this is frequently done, 
and may vote such stock, though in some States 
the pledgee, upon the demand of the pledgor, must 
give the latter a proxy to vote the stock. The 
pledgee is liable for assessments on the stock stand- 
ing in his name, though by statute in some States 
the pledgor and not the pledgee is liable; but the 
pledgee may charge against his pledgor the amount 
so paid. The pledgee is entitled to be reimbursed 
for necessary expenses in keeping the pledge. The 
pledgee may assign his interest, and this he does 
by assigning both the debt secured and the pledge. 
131. PLEDGEE'S RIGHT TO HYPOTHE- 
CATE PLEDGED STOCK. — Where a broker 
purchases stock for a customer who deals with him 
on margin (creating the relation of pledgor and 
pledgee), it seems that the broker has the right to 
hypothecate the stock, at least to the extent that 
the broker has advanced his own money in the pur- 
chase. He is not bound to keep on hand the identi- 
cal stock purchased, but still he must have on hand 
or under his control at all times ready for delivery 
to his customer shares of the same description, 



LOANS AND INVESTMENTS 145 

and in amount sufficient to fill the customer's order. 
Ke has no right to pledge his customer's stock 
beyond this, and commits the wrong of conversion 
if he does; but if he does, and there is nothing on 
the certificate to warn the broker's pledgee that it 
is already pledged, this second pledgee takes it 
free from any claims of the customer, and need 
not surrender it to the owner (purchaser) except 
on payment of the debt of the broker for which it 
was the second time pledged. This is owing to the 
rule already discussed that one who clothes another 
with apparent ownership cannot dispute the title 
of a buyer or pledgee from such person in good 
faith for value and without notice. The right to 
use, sell, or rehypothecate the pledge may be'given 
by a pledge agreement, and is a common clause 
in collateral notes. 

132. REDELIVERY AND CONVERSION. 
— The pledgee must redeliver the identical thing 
pledged, with the increase and profits, upon tender 
of redemption by the pledgor, except that he need 
not deliver the identical certificates of stock. If 
the pledgee does not redeliver he is guilty of con- 
version, as he is at the time he makes an unwar- 
ranted use or disposal of the pledge. The rule as 
to measure of damage is generally the value at the 
date of conversion, without reference to the nature 
of the pledge. In New York State and in the 
United States courts, in the case of conversion of 
stocks, it is the highest value within a reasonable 



146 LOANS AND INVESTMENTS 

time after the pledgor becomes aware of the con- 
version; in other States it is the value at date of 
demand, or the highest intermediate value between 
date of conversion and the date of trial, or the value 
at date of conversion. 

133. RIGHTS OF PLEDGEE AFTER DE- 
FAULT. — The pledgee upon default in redemption 
at the agreed time by the pledgor, may sue the 
pledgor upon the debt for which the pledge was 
given as security, and may recover judgment with- 
out affecting his lien on the property pledged ; the 
property pledged may then be applied on the 
amount of the debt as represented by the judgment. 
After default in redemption by the pledgor, the 
pledgee, on notice to the pledgor, and demand of 
performance, and on reasonable notice of the time 
and place of sale, may sell the property pledged at 
public sale. Demand of performance is waived by 
positive refusal to perform after performance is 
due, but the pledgor's right to notice of sale is not 
thereby waived. This right to sell applies to all 
property pledged except negotiable instruments; 
these the pledgee must hold and collect as they 
become due and apply the proceeds to the debt, in 
the absence of a special power of sale. The reason 
is that negotiable paper would never bring its true 
value on a forced sale. The general power of the 
pledgee to sell may be modified or enlarged by the 
pledge agreement. Thus banks ordinarily require 
of their borrowers a note waiving notice of time 



LOANS AND INVESTMENTS 147 

and place of sale, and providing for private sale, 
and many other provisions. A sale at a recognized 
stock exchange has been held to be a sale at public 
auction, but the point has not been clearly settled. 
The pledgee, in the absence of agreement, has no 
right to buy at the sale. If the subject matter of 
the pledge can be divided the pledgee may sell only 
such part as will discharge the debt; otherwise he 
is liable for conversion of the part not necessary to 
be sold. The notice should be served or given to 
the pledgor in person, or to an authorized agent 
if the pledgor have one. 

134. TERMINATION OF PLEDGE. — A 
pledge is not terminated by the death or bank- 
ruptcy oi the pledgor, but at the termination of 
the pledge agreement the pledgor's representatives 
may make tender of the debt and demand the prop- 
erty, and in default of such tender the pledgee may 
sue the pledgor's representatives or sell upon notice 
to them. Payment terminates the pledge as does 
redelivery, tender or sale, and if the pledgee does 
not redeliver on a good and valid tender he converts 
the pledge and may be sued for the value of the 
property. 

135. WAREHOUSEMEN AND WARE- 
HOUSE RECEIPTS.— The law relating to ware- 
housemen and warehouse receipts is a branch of the 
law of bailments. A warehouseman is one engaged 
in the business of storing goods for others for com- 
pensation. He is a bailee for hire and is required 



148 LOANS AND INVESTMENTS 

by law to use reasonable skill and diligence, or 
"ordinary" care as it is technically termed, in re- 
spect to the property entrusted to him. Ordinary 
care is that degree of care which men of common 
prudence would exercise under similar circum- 
stances with regard to their own property. A ware- 
houseman is liable for ordinary negligence, or a 
want of reasonable care. He is not an insurer 
of the goods and is not responsible for their loss 
where he has exercised ordinary care. A ware- 
house receipt is a written acknowledgment by a 
warehouseman that he holds certain described 
goods in store for delivery to the person to whom 
the receipt is issued or to his order where the 
receipt is negotiable. The Uniform Warehouse 
Receipts Act, which is now the law of thirty-three 
States, codifies and makes uniform the law of ware- 
house receipts. 

136. COMMON AND STATUTORY LAW. 
— At common law, independent of statute, ware- 
house receipts were assignable by delivery, or by 
endorsement and delivery, and their transfer passed 
to the assignee the title of the assignor to the prop- 
erty. The transfer of the warehouse receipt had 
the same effect as delivery of the goods themselves 
and vested in the assignee the constructive posses- 
sion, but he took no better right or title than that 
possessed by the assignor. A valid transfer can be 
made by a mere delivery of the receipt with intent 
to pass title to the goods, without endorsement, 



LOANS AND INVESTMENTS 149 

and statutes authorizing transfer of warehouse re- 
ceipts by endorsement have been generally con- 
strued not to invalidate a transfer of title by mere 
delivery. But common law transfers, if they may 
be so called, did not give to the assignee any greater 
rights than the assignor possessed, and in a large 
number of States, prior to the enactment of the 
Warehouse Receipts Act, statutes were passed 
declaring warehouse receipts negotiable. These 
statutes, however, have been construed by the 
courts as not conferring upon warehouse receipts 
the full measure of negotiability which is possessed 
by bills of exchange or promissory notes. They 
gave to the holder to whom a receipt had been 
regularly transferred by endorsement, the effect of 
manual delivery of the goods represented; they 
served to dispense with notice to the warehouse- 
man that the receipt had been transferred, which 
notice was generally otherwise necessary to protect 
the holder from delivery of the goods to the original 
bailor; and their effect was to transfer the title to 
a bona fide purchaser free from any equities of 
prior parties not apparent on the face of the in- 
strument. They did not, however, confer upon the 
transferee title to the goods as against one who 
had a superior title to the transferor, nor confer 
title where the receipt was innocently acquired 
from a thief or finder, as against the true owner. 
The Uniform Warehouse Receipts Act, which codi- 
fies and makes uniform the common and statute 



150 LOANS AND INVESTMENTS 

law, provides for two kinds of receipt, non-negotia- 
ble and negotiable. The non-negotiable receipt is 
one in which it is stated that the goods received 
will be delivered to the depositor or to any other 
specified person. The negotiable receipt is one in 
which it is stated that the goods will be delivered 
to the bearer or to the order of any person named 
in such receipt. 

137. NON-NEGOTIABLE WAREHOUSE 
RECEIPTS.— A non-negotiable receipt is not, gen- 
erally speaking, a document upon which the banker 
should advance value and receive in pledge. The 
transferee acquires as against the transferor, the 
title to the goods, subject to the terms of any agree- 
ment with the transferor, and he acquires the direct 
obligation of the warehouseman to hold possession 
of the goods for him according to the terms of the 
receipt. But prior to such notification, the title of 
the transferee to the goods and the right to acquire 
the obligation of the warehouseman may be de- 
feated by the levy of an attachment or execution 
upon the goods by a creditor of the transferee or 
by a notification to the warehouseman by the trans- 
feror or a subsequent purchaser from the transferee 
of a subsequent sale of the goods by the transferor. 
Furthermore, in case the goods are delivered by the 
warehouseman to the transferor prior to notifica- 
tion, the rights of the assignee or pledgee would 
be endangered, if not defeated, as the warehouse- 
man would not be responsible, although the receipt 



LOANS AND INVESTMENTS 151 

was not produced and surrendered when the de- 
livery was made. The banker, therefore, is not 
particularly concerned with the non-negotiable 
warehouse receipt except to let it alone and to have 
an ability to know whether a receipt is non-nego- 
tiable or negotiable. 

138. NEGOTIABLE WAREHOUSE RE- 
CEIPTS. — Negotiable warehouse receipts are very 
extensively pledged to bankers as collateral for 
loans, but even under the Uniform Warehouse 
Receipts Act they do not possess the full measure 
of negotiability accorded by the law to bills of 
exchange and promissory notes. They are nego- 
tiable by endorsement and delivery, or by delivery 
alone if in form so permitting, in the same way as 
bills and notes, but although the receipt is, in form, 
capable of being negotiated by delivery, as by en- 
dorsement in blank, the bona fide transferee for 
value from a thief or finder takes no title as against 
the true owner. This is one risk which the banker, 
as pledgee for value, incurs. If, however, a person 
entrusted with a negotiable receipt by the owner 
for a special purpose abuses his trust and makes a 
wrongful negotiation, the bona fide transferee is 
protected as against the owner. The transferee of 
a negotiable receipt is also protected in his right 
to the goods as against a delivery by the warehouse- 
man without taking up the receipt. The Ware- 
house Receipts Act requires, except in certain 
special cases, such as sale to satisfy warehouse- 



152 LOANS AND INVESTMENTS 

man's lien or in case of perishable or hazardous 
goods, that where a warehouseman delivers goods 
represented by a negotiable receipt he must take 
up and cancel the receipt, or in case of partial de- 
livery, make endorsement thereon, and failure to 
do this makes him liable to the holder for value of 
the outstanding receipt, whether the same was ac- 
quired before or after such delivery, and such failure 
is also made a criminal offense. This provision 
applies only to negotiable receipts and without it 
such receipts would frequently be valueless as se- 
curity. Goods represented by an outstanding ne- 
gotiable receipt are, by the Warehouse Receipts 
Act, exempted from attachment or garnishment 
by a creditor of the depositor while in the posses- 
sion of the warehouseman, unless the receipt is first 
surrendered or its negotiation enjoined. This is 
an important provision for the protection of the 
banker who takes the receipt as security for a loan. 
139. WAREHOUSEMEN'S LIABILITY. — 
The Uniform Warehouse Receipts Act thus pro- 
vides the rule of liability for contents of packages: 
"A warehouseman shall be liable to the holder of 
a receipt for damages caused by the non-existence 
of the goods or by the failure of the goods to cor- 
respond with the description thereof in the receipt 
at the time of its issue. If, however, the goods are 
described in a receipt merely by a statement of 
marks or labels upon them, or upon packages con- 
taining them, or by a statement that the goods are 



LOANS AND INVESTMENTS 153 

said to be goods of a certain kind, or that the pack- 
ages containing the goods are said to contain goods 
of a certain kind, or by words of like purport, such 
statements, if true, shall not make liable the ware- 
houseman issuing the receipt, although the goods 
are not of the kind which the marks or labels upon 
them indicate, or of the kind they were said to be 
by the depositor." 

140. AGENTS OF WAREHOUSEMEN.— 
A further important question is whether a ware- 
houseman, whose agent signs and issues a ware- 
house receipt for goods which have not in fact been 
received, is responsible to a transferee of the receipt 
for the goods stated to have been received. The 
rule of the common law, which has had a more 
extensive application to cases of false bills of lading 
issued by agents of carriers, was that the principal 
was not bound, as the authority of the agent only 
extended to the issue of receipts where goods had 
been actually received and a receipt issued for goods 
not in fact received was an act beyond the authority 
of the agent and not binding on the principal even 
in favor of a bona fide holder of the receipt. A few 
States, among others New York and Pennsylvania, 
hold the principal liable for the act of his agent in 
such cases upon the theory of estoppel. The Uni- 
form Warehouse Receipts Act in the provision last 
above quoted changes the common law rule. It 
provides that "a warehouseman shall be liable to 
the holder of a receipt for damages caused by the 



154 LOANS AND INVESTMENTS 

non-existence of the goods * * * " and this, 
coupled with a further provision of the Act that 
"the signature of the warehouseman may be made 
by his authorized agent" makes him responsible to 
a bona fide holder of a warehouse receipt which 
acknowledges the receipt of goods not in fact re- 
ceived. The banker, therefore, who loans money 
upon a warehouse receipt falsely acknowledging 
the receipt of 300 tubs of butter, or any other com- 
modity, can compel the warehouseman to make it 
good. 

141. WARRANTIES OF GENUINENESS.— 
Where a receipt is negotiated or transferred for 
value, the Warehouse Receipts Act provides a war- 
ranty by the transferor of the receipt or of a claim 
secured thereby, of the genuineness of the receipt, 
that he has a legal right to negotiate or transfer it, 
and that he has no knowledge of any fact which 
would impair the validity or worth of the receipt. 
Also that he has a right to transfer title to the 
goods and that the goods are merchantable or fit 
for a particular purpose whenever such warranties 
would have been implied, if the contract of the 
parties had been to transfer without a receipt the 
goods represented thereby. This would enable a 
banker, who took as pledge for a loan a forged re- 
ceipt or a stolen receipt or a receipt for goods not 
owned by the person who obtained the loan, to hold 
the borrower responsible upon his warranty. But 
the law exempts a pledgee of the receipt who re- 



LOANS AND INVESTMENTS 155 

ceives payment of the debt for which the receipt 
is given as security, either from the drawee of a 
draft therefor or from any other person, from lia- 
bility as warrantor of the genuineness of the receipt 
or of the quantity or quality of the goods therein 
described. 

142. LIABILITY OF ENDORSERS. — Al- 
though a person who negotiates and sells a ware- 
house receipt to another, for value, warrants the 
genuineness of the receipt and the other matters 
above specified, he does not, by endorsing the re- 
ceipt, incur the ordinary liabilities which attach to 
the endorser of a promissory note in case of default 
of the maker. The Warehouse Receipts Act pro- 
vides that "the endorsement of a receipt shall not 
make the endorser liable for any failure on the part 
of the warehouseman or previous endorsers of the 
receipt to fulfill their respective obligations." This 
is the law apart from the Warehouse Receipts Act 
and has been so ruled, even where State statutes 
have made warehouse receipts negotiable. The 
liability is analogous to that of an endorser "with- 
out recourse" of a promissory note. If the note is 
not paid, the endorser cannot be held, but if the 
note was a forgery or there was any defect of title, 
he would be liable as warrantor. 

143. WAREHOUSEMEN'S LIENS* ~~ The 
warehouseman has a lien on the goods for his 
charges, and statutes in many States have required 
that his lien be stated in the receipt, otherwise he 



156. LOANS AND INVESTMENTS 

cannot enforce such lien against the transferee for 
value of the receipt. It is obvious that negotiable 
receipts should show on their face what charges 
are claimed against the goods. The Uniform 
Warehouse Receipts Act requires that every re- 
ceipt must embody "a statement of the amount of 
advances made and of liabilities incurred for which 
the warehouseman claims a lien. If the precise 
amount of such advances made or of such liabilities 
incurred is, at the time of the issue of the receipt, 
unknown to the warehouseman or to his agent 
who issues it, a statement of the fact that advances 
have been made or liabilities incurred and the pur- 
pose thereof is sufficient." 

144. EXTENSIVE USE OF WAREHOUSE 
RECEIPTS. — A bona fide purchaser of a ware- 
house receipt is one who has taken the receipt for 
value without notice of defect in the title of the 
transferor. A pledgee who takes a warehouse re- 
ceipt as security for a loan is a purchaser for value, 
and he acquires the pledgor's title to the property, 
so far as necessary to effect the object of the pledge. 
By means of the Negotiable Warehouse receipt, 
owners of millions of dollars of stored goods are 
enabled, through pledge of the receipt, to obtain 
needed loans and advances upon the security thereof, 
and tide themselves over periods when the goods 
are not readily salable. The warehouse receipt is 
in many respects analogous to the bill of lading; 
one represents goods in store, the other goods in 



LOANS AND INVESTMENTS 157 

transit. Both are now used to an enormous extent 
as instruments of credit, and loans and advances 
which run into the billions of dollars are annually 
made upon faith thereof. 

145, COMMON CARRIERS.— The transporta- 
tion of merchandise by water and by land, from one 
point to another at shorter or longer distances, is 
a business of vast extent in our modern commerce. 
The person or corporation who conducts this busi- 
ness is termed a carrier. Carriers are of two classes, 
private carriers and public or common carriers. A 
private carrier is one who undertakes isolated cases 
of transportation and whose usual vocation is dif- 
ferent. He is a bailee of the goods entrusted to him 
and, like other bailees, is bound to use ordinary 
care where he carries for hire and a less degree of 
care if the carriage is gratuitous. A common car- 
rier is one whose regular calling is to transport, 
for hire, goods and chattels for all who may choose 
to employ and remunerate him. The common 
carrier differs from an ordinary bailee in two im- 
portant particulars (1) he is bound, according to 
his facilities, to transport all goods which are 
offered to him when coupled with proper remunera- 
tion, (2) his common law liability is exceptional. 
He is responsible for the goods, where lost or dam- 
aged, as an insurer, except where the loss is caused 
by act of God or public enemy. 

146. BILLS OF LADING.— A bill of lading 
is a written acknowledgment by the carrier of the 



158 LOANS AND INVESTMENTS 

receipt of the described goods, and an agreement, 
for a consideration, to transport and deliver the 
same at a specified place to the consignee or person 
designated therein. The bill of lading must be 
signed by the carrier, but it has been quite generally 
held, with some few exceptions, that it need not 
be signed by the shipper, and that the acceptance of 
the bill by the shipper binds him to the terms of the 
contract. The Uniform Bill of Lading Act provides 
for the signature of the shipper, but the shipper does 
not always sign and without his signature its ac- 
ceptance by him completes the contract and binds 
both parties to its terms. Bills of lading now in 
common use are of two kinds, the Straight bill of 
lading and the Order bill of lading. The Straight 
bill of lading is an acknowledgment of the receipt 
of goods and an agreement to carry and deliver to 
a named consignee at destination. When this 
agreement is fulfilled by the carrier its contract 
is performed. The Straight bill contains no con- 
tract of the carrier that he will require surrender 
of the bill before delivery of the goods. The Order 
bill of lading is a like receipt, but the contract is to 
carry and deliver to the order of a specified person, 
generally the shipper, and it contains an express 
agreement that the surrender of the bill, properly 
endorsed, shall be required by the carrier before 
delivery of the property. In the forms approved 
and recommended by the Interstate Commerce 
Commission and generally used by carriers, the 



LOANS AND INVESTMENTS 159 

Straight and Order forms of bill are identical, in- 
cluding certain conditions on the back, except that 
the Straight bill omits the following matters con- 
tained in the Order bill: (1) the surrender clause, 
.(2) the inspection clause, (3) the words "order of 
and (4) the word "notify, 95 indicating the person to 
be notified of the arrival of the goods. 

147. NEGOTIATION OF ORDER BILLS.— 
The Uniform Bills of Lading Act, which has been 
enacted in sixteen States and is a companion act to 
the Warehouse Receipts Act, makes a distinction 
between Straight or non-negotiable and Order or 
negotiable bills of lading and provides that "a nego- 
tiable bill may be negotiated by any person in 
possession of the same, however such possession 
may have been acquired, if by the terms of the bill 
the carrier undertakes to deliver the goods to the 
order of such person, or if at the time of negotiation 
the bill is in such form that it may be negotiated: 
by delivery." The Uniform Bills of Lading Act, in 
modified form, has also been passed by Congress 
to take effect January 1, 1917. It applies to bills of 
lading issued in interstate and foreign commerce. 
Among its provisions is the one just quoted relat- 
ing to negotiation of Order bills. This provision 
gives a greater degree of negotiability than here- 
tofore to Order bills of lading, because under it the 
bona fide purchaser can acquire good title from a 
thief or finder, if endorsed in blank so as to be 
capable of negotiation by delivery. Order bills of 



160 LOANS AND INVESTMENTS 

lading, however, are not in all respects on the same 
footing as Straight bills of lading, for, as in the case 
of warehouse receipts, there is no liability of the 
carrier as insurer of the contents of packages where 
he has described such contents merely by a state- 
ment of the marks and labels upon them, and there 
is no liability of an endorser, as in the case of prom- 
issory notes, for default of the maker or prior en- 
dorsers. The banker who loans money or makes 
advances to one who assigns the bill of lading as 
security is chiefly concerned with the Order bill 
of lading. The Straight bill of lading affords him 
no security, for there is no obligation of the carrier 
to hold possession of the goods for the holder of 
the bill, and their delivery to the consignee before 
notice of the assignment of the bill of lading would 
protect the carrier. The only bill of lading, there- 
fore, which should be considered as security by the 
banker is the Order bill, and even the taking of this 
bill as collateral is sometimes attended with certain 
risks. 

148. FALSE BILLS. — Heretofore a serious 
risk to the purchaser or pledgee of an Order bill 
of lading has arisen from the issue by the agent 
of the carrier of a bill of lading acknowledg- 
ing the receipt of goods not in fact received. 
This might be done (1) mistakenly, (2) fraudu- 
lently, as by collusion where there are no goods, 
(3) as a matter of accommodation to the shipper, 
to furnish him in advance with the means of ob- 



LOANS AND INVESTMENTS 161 

taining credit and in the expectation that the goods 
for which the bill has been prematurely issued will 
be ultimately delivered to the carrier for transporta- 
tion. By the rule of the common law which, before 
the enactment by Congress of the modified Uniform 
Bills of Lading Act, entitled "an act relating to 
bills of lading in interstate and foreign commerce," 
was recognized and applied by the Federal courts 
and by many State courts, the carrier was not liable 
to a bona fide transferee or pledgee of the bill in 
such case. The authority of the agent to sign and 
issue bills of lading was held to exist only where 
he had already received the goods and not to exist 
in the absence of such receipt. Where he signed 
and issued a bill, therefore, which acknowledged 
the receipt of goods not in fact received, it was his 
own act and not the act of the carrier, and the latter 
was not bound to a transferee for value of the bill. 
In some eight States the courts have refused to 
apply this rule, and have held the carrier liable on 
the ground that by holding his agent out to the 
public as authorized to issue bills of lading he has 
clothed him with an apparent authority in such 
cases which the carrier is estopped to deny. In 
some dozen or more States, special statutes have 
also been enacted making the carrier liable, and 
such liability is also provided by the Uniform Bills 
of Lading Act, wherein the issue or negotiation 
of bills without goods is also made a criminal 
offense. The enactment by Congress of the Bills of 



162 LOANS AND INVESTMENTS 

Lading Act above referred to, provides such lia- 
bility in cases of interstate and foreign shipments, 
and overturns the rule of non-liability applied by 
the Federal courts. The operation of such rule is 
now limited to intrastate shipments in a few States 
only, where the Uniform Bills of Lading Act has 
not been passed. The establishment of a liability 
of the carrier for the truth of the statements in the 
bill of lading is of vital importance, for otherwise, 
wherever money is loaned upon a bill of lading 
acknowledging the receipt of 100 bales of cotton, 
or two carloads of shingles or 500 sacks of potatoes, 
and no cotton, shingles or potatoes are behind the 
bill, the money is lost, for in such cases the shipper 
is generally irresponsible. The act of Congress 
also makes it a criminal offense to negotiate or 
transfer for value "a bill which contains a false 
statement as to the receipt of the goods." 

149. SPENT BILLS.— Another but less seri- 
ous risk, owing to its lesser frequency, grows out 
of the rule applied by some State courts, though 
not recognized in others, that where the goods 
represented by an Order bill have been delivered 
to a person holding the bill and rightfully entitled 
thereto, but without requiring surrender of the bill, 
the contract of the carrier has been performed, the 
functions of the bill have ceased and it becomes a 
spent or dead bill. Where this rule is applied, 
should the holder of the unsurrendered bill, after 
receiving the goods, fraudulently negotiate the bill, 



LOANS AND INVESTMENTS 163 

the holder would acquire no enforceable rights, and 
herein lies the risk. The Uniform Bills of Lading 
Act provides a liability of the carrier to the holder 
for value to whom a spent bill has been negotiated, 
and a similar liability is provided by act of Con- 
gress. The negotiation of spent bills is also made 
criminal by the State Uniform Bills of Lading Act. 

150. ALTERED BILLS.— At common law, a 
material alteration of a contract without consent 
of the person obligated, destroyed it, and the holder 
of such altered contract had no enforceable rights 
therein. Both by one of the conditions of the 
Uniform Bills of Lading and by provision of the 
Uniform Act, an altered contract is now enforceable 
for its original tenor and not destroyed completely. 
The act of Congress also provides "that any alter- 
ation, addition or erasure in a bill after its issue 
without authority from the carrier issuing the same, 
either in writing or noted on the bill, shall be void, 
whatever be the nature and purpose of the change, 
and the bill shall be enforceable according to its 
original tenor." The risk from acquiring altered 
bills has therefore been lessened, although there 
is still danger of loss in the case of raised bills, as 
where a bill acknowledging receipt of 10 boxes is 
fraudulently raised to 100. 

151. GOODS NOT OWNED BY SHIPPER. 
—Another, though infrequent, risk attendant upon 
the giving of value upon the faith of an Order bill 
of lading arises in the case where the shipper is 



164 LOANS AND INVESTMENTS 

not owner of the goods shipped and is wrongfully 
in possession of them. He delivers the goods to 
the carrier and receives an Order bill of lading 
therefor, upon which he obtains an advance. The 
holder of the bill as security would, in this case, 
have no right to the goods as against the true 
owner. 

152. GOODS LOST OR DAMAGED IN 
TRANSIT. — Where goods are lost or damaged 
in transit through a cause for which the carrier is 
exempted from responsibility by virtue of the con- 
ditions in the bill of lading, of course there is an 
impairment or loss of the security, as represented 
by the bill of lading, unless there is coupled with 
the bill of lading an insurance contract against such 
loss. But in this particular case the risk is not as 
great as might first appear, because the shipper or 
owner of the goods to whom the advance has been 
made upon security of the bill of lading, is generally 
a responsible person who is liable for and will be 
able to pay the money loaned, although the security 
for such loan has been destroyed. It is only in 
cases where insolvency or irresponsibility of the 
shipper or debtor is concurrent with loss of the 
goods from a cause for which the carrier is not 
responsible that the holder of the security will 
suffer. 

153. ATTACHMENT OF GOODS REP- 
RESENTED BY BILLS OF LADING.— Numer- 
ous cases have arisen in many of the State courts 



LOANS AND INVESTMENTS 165 

where goods represented by an Order bill of lading 
outstanding in the hands of a banker as pledgee 
for value have been attached while in the possession 
of the carrier by a creditor of the shipper. Lpwer 
courts in many of these cases have failed to recog- 
nize the rights of the banker holding the bill, and 
have sustained the attachment; but almost in- 
variably the higher courts of the different States 
have upheld his rights, as pledgee for value of the 
bill, as against the attaching creditor. In some 
cases where the banker has been proved to be only 
a collecting agent of the shipper, and not to have 
advanced value for or given credit for the draft to 
which the bill of lading is attached, the attach- 
ments have been held valid; but wherever the 
banker has taken title to the draft with the bill of 
lading as security therefor, whether the full value 
has been actually paid out to the shipper or only 
credited to him in his bank account, the superior 
rights of the banker as pledgee of the bill have been 
upheld. The Uniform Bills of Lading Act pro- 
vides an exemption from attachment of goods rep- 
resented by an outstanding negotiable or Order 
bill of lading as follows: "If goods are delivered 
to a carrier by the owner, or by a person whose act 
in conveying the title to them to a purchaser for 
value in good faith would bind the owner, and a ne- 
gotiable bill is issued for them, they can not there- 
after, while in the possession of the carrier, be 
attached by garnishment or otherwise, or be levied 



166 LOANS AND INVESTMENTS 

upon under an execution, unless the bill be first 
surrendered to the carrier or its negotiation en- 
joined. The carrier shall in no such case be com- 
pelled to deliver the actual possession of the goods 
until the bill is surrendered to him or impounded 
by the court.'' The same language is contained in 
the act of Congress except that the bill is termed 
an "order" instead of a "negotiable" bill. 

154. NON-LIABILITY OF PLEDGEE AS 
WARRANTOR.— In 1898 a court in Texas held 
that a bank which had purchased a draft secured 
by bill of lading for wheat and collected the amount 
of the draft from the drawee, surrendering to him 
the bill of lading, was liable to the drawee for the 
amount collected where it turned out that the wheat 
was musty and of an inferior quality than that 
contracted for. The theory of the court was that 
the bank was not only a purchaser of the draft, 
but also a purchaser and seller of the wheat to 
the drawee and an implied warrantor of the se- 
curity. This doctrine was soon afterwards fol- 
lowed by the Supreme Courts of North Carolina, 
Alabama and Mississippi, but was subsequently 
overturned in later cases in three of the four States 
named, leaving the State of Mississippi as the only 
one whose courts still adhere to this doctrine. The 
contrary doctrine, that the bank purchasing a draft 
and taking an assignment of the bill of lading in 
pledge by way of security does not warrant the 
genuineness of the bill or the quantity, quality or 



LOANS AND INVESTMENTS 167 

condition of the goods, has been declared by the 
Supreme Court of the United States and by a large 
number of State courts, and is now expressly pro- 
vided by the Uniform Bills of Lading Act, which, 
however, provides the same warranties by seller to 
purchaser as in case of transfer of warehouse re- 
ceipts. Similar provisions are contained in the act 
of Congress. 

155. SHIPPER'S LOAD AND COUNT.— 
In cases where the goods represented by bills of 
lading are loaded and counted by the shipper—and 
this is frequently the case where large factories are 
located on spurs and sidings away from the main 
track and away from the railroad freight depot- 
trie practice is for the carrier to stamp on such 
bills the words "shipper's load and count," which 
indicate that the shipper has loaded and counted 
the contents of a particular car or shipment, and 
that the carrier is not responsible for the correct- 
ness thereof. Obviously such bills, although they 
may be Order bills, are not a safe basis of collateral, 
for the integrity of the bill as to value of the ship- 
ment rests entirely on the honesty of the shipper, 
and the carrier is not responsible. The act of 
Congressoprohibits the insertion of words of this 
character when goods are loaded by the carrier, 
and also in certain cases where loaded by the ship- 
per; that is to say, where the shipper of bulk 
freight maintains adequate facilities for weighing 
such freight, which are available to the carrier, and 



168 LOANS AND INVESTMENTS 

makes written request of, and gives reasonable op- 
portunity to, the carrier to ascertain the kind and 
quantity of bulk freight, the carrier must do so 
within reasonable time, and is prohibited from in- 
serting in the bill "shipper's weight" or words of 
like purport. 

156. WORD "NOTIFY" ON ORDER BILLS. 
—It is sometimes assumed that the word "notify" 
on an Order bill of lading carries notice that the 
person to be notified has some right or equity in 
the goods which might be asserted as against a 
pledgee for value, and that it is therefore unsafe to 
advance value upon such a bill. This is an er- 
roneous assumption. The original form of bill of 
lading was the Straight bill. But as under this bill 
the carrier could deliver the goods to the con- 
signee without taking up the bill, the shipper had 
no means of retaining the goods as security until 
he received payment of the purchase price. The 
practice, therefore, became common of issuing bills 
to order of the shipper, under which the carrier was 
required to hold the goods and make delivery only 
to the holder of and upon surrender of the Order 
bill. The shipper would attach his bill to a draft 
and forward it for collection and upon payment of 
the draft by the purchaser of the goods, the bill 
would be delivered to him and enable him to obtain 
the goods from the carrier. The word "notify" 
on such bills simply indicates a request to the 
carrier that upon arrival of the goods he will notify 



LOANS AND INVESTMENTS 169 

the person for whom they are intended that he 
may, by paying the draft and obtaining possession 
of and surrendering the bill of lading, receive de- 
livery of the goods. In addition to sending the 
draft and Order bill for collection, the practice is 
now common for the shipper to obtain an advance 
on the documents from his local banker, who, as 
owner of the draft with the bill of lading attached 
as security, has the collection made for his own 
account. The Uniform Bills of Lading' Act clears 
up all doubt as to the effect of the word "notify" 
in an Order bill by providing that "the insertion in 
a negotiable bill of the name of a person to be noti- 
fied of the arrival of the goods shall not limit the 
negotiability of the bill or constitute notice to a 
purchaser thereof of any rights or equities of such 
person in the goods." The same provision is in the 
act of Congress. 

157. SURRENDER OF BILLS OF LADING 
TO DRAWEES.— Considerable doubt has arisen 
in the past in the minds of bankers holding drafts 
with bills of lading for collection, and some litiga- 
tion has resulted, concerning the duty of the col- 
lecting bank to surrender the bill of lading to the 
drawee upon acceptance of the draft or his obliga- 
tion to hold the security until the draft is actually 
paid. The following provisions of the Uniform 
Bills of Lading Act thus regulate the subject in 
accordance with the weight of authority: Where 
the seller of goods draws on the buyer for the price 



170 LOANS AND INVESTMENTS 

of the goods and transmits the draft and a bill of 
lading for the goods either directly to the buyer or 
through a bank or other agency, unless a different 
intention on the part of the seller appears, the 
buyer and all other parties interested shall be justi- 
fied in assuming: (a) If the draft is by its terms 
or legal effect payable on demand or presentation 
or at sight, or not more than three days thereafter 
(whether such three days be termed days of grace 
or not), that the seller intended to require pay- 
ment of the draft before the buyer should be en- 
titled to receive or retain the bill, (b) If the draft 
is by its terms payable on time, extending beyond 
three days after demand, presentation or sight 
(whether such three days be termed days of grace 
or not), that the seller intended to require accept- 
ance, but not payment of the draft before the buyer 
should be entitled to receive or retain the bill. The 
provisi@ns of this section are applicable whether 
by the terms of the bill the goods are consigned to 
the seller, or to his order, or to the buyer, or to his 
order, or to a third person, or to his order. These 
provisions, however, are not contained in the Act 
of Congress. 

158. COLLATERAL NOTES.— Banks doing 
an extensive collateral loan business usually have 
a special form of collateral note. Such forms vary 
in some particulars but the following is a typical 
specimen: 



LOANS AND INVESTMENTS 171 

New York ,191 

$ 

after date, FOR VALUE RECEIVED, the 

undersigned jointly and severally promise to pay to the 
order of THE INSTITUTE BANK OF NEW YORK 
(hereinafter called the Bank), at its Banking Office in New 

York City, DOLLARS, in United 

States gold coin or its equivalent, having deposited with the 
Bank, as collateral security for the payment of this note, or 
any note given in extension or renewal thereof, as well as 
for the payment of any other obligation or liability, direct 
or contingent, of the undersigned, or any of them, to the 
Bank, due or to become due, whether now existing or here- 
after arising, the following property, viz. : ., 

[Space for enumeration of collateral] 

of a market value estimated by the undersigned at $ "; 

and the undersigned agree to deliver to the Bank additional 
securities, or to make payments on account to its satisfac- 
tion, should the market value of the said securities, as a 
whole, suffer any decline. The undersigned hereby give to the 
Bank a lien for the amount of all such obligations and liabili- 
ties upon all the property or securities now or at any time 
hereafter given unto or left in the possession of the Bank by 
the undersigned, whether for the express purpose of being 
used by the Bank as collateral security, or for any other or 
different purpose, and also upon any balance of the deposit 
account of the undersigned, or any of them, with the Bank. 
On the non-performance of this promise, or upon the non- 
payment of any of the obligations or liabilities above men- 
tioned, or upon the failure of the undersigned, forthwith, 
with or without notice, to furnish satisfactory additional 
securities, or to make payments on account, in case of de- 
cline, as aforesaid, or in case of insolvency, bankruptcy, or 
failure in business of the undersigned, or any of them, then 
and in any such case, this note and all other obligations and 



172 LOANS AND INVESTMENTS 

liabilities, direct or contingent, of the undersigned and each 
of them, shall forthwith become due and payable, without 
demand or notice ; and full power and authority are hereby 
given to the Bank to sell, assign, and deliver the whole of 
the said securities, or any part thereof, or any substitutes 
therefor, or any additions thereto, or any other securities 
or property given unto or left in the possession of the Bank 
by the undersigned, whether for the express purpose of be- 
ing used by the Bank as collateral security, or for any other 
or different purpose, or in transit to or from the Bank, by 
mail or carrier, for any of the said purposes, at any broker's 
board, or at public or private sale, at the option of the Bank, 
without either demand, advertisement or notice of any kind, 
all of which are hereby expressly waived. At any such sale, 
the Bank may itself purchase the whole or any part of the 
property sold, free from any right of redemption on the part 
of the undersigned, which is hereby waived and released. 
In case of any sale or other disposition of any of the prop- 
erty aforesaid, after deducting all costs, or expenses of every 
kind for collection, sale or delivery, the Bank may apply the 
residue of the proceeds of the sale or sales so made, to pay 
one or more or all of the said obligations or liabilities to it, 
whether then due or not due, making proper rebate for inter- 
est on obligations or liabilities not then due, and returning 
the overplus, if any, to the undersigned, who agree to be 
and remain liable, jointly and severally, to the Bank for any 
deficiency arising upon such sale or sales. The undersigned 
do hereby authorize and empower the Bank, at its option, 
at any time, to appropriate and apply to the payment and 
extinguishment of any of the obligations or liabilities, here- 
inbefore referred to, whether now existing or hereafter con- 
tracted and whether then due or not due, any and all moneys 
now or hereafter in the hands of the Bank, on deposit or 
otherwise, to the credit of or belonging to the undersigned, 
or any of them. 



LOANS AND INVESTMENTS 173 

The Bank may transfer this note and may deliver the said 
collateral security or any part thereof to the transferee or 
transferees, who shall thereupon become vested with all the 
powers and rights above given to the Bank in respect there- 
to; and the Bank shall thereafter be forever relieved and 
fully discharged from any liability or responsibility in the 
matter. No delay on the part of the holder hereof, in exer- 
cising any rights hereunder, shall operate as a waiver of 
such rights. 

1 59. COLLATERAL LOAN AGREEMENTS. 
— Sometimes a special form of contract similar to 
the following is made between banks and regular 
loan customers : 

WHEREAS, the undersigned expect, from time to time, to 
borrow money from THE INSTITUTE BANK OF NEW 
YORK (hereinafter called the Bank) and to pledge with the 
Bank property of various kinds as collateral security for the 
payment of such loan or loans to be hereafter made by the 
Bank; Now, therefore, 

IT IS AGREED by the undersigned with the Bank, that all 
property thus pledged with it may be held by it as collateral 
security for the payment of such loan or loans as well as for 
the payment of any other obligation or liability, direct or 
contingent, of the undersigned, or any of them, to the Bank, 
due or to become due, whether now existing or hereafter 
arising; and the undersigned agree to deliver to the Bank 
additional securities, or to make payments on account to its 
satisfaction, should the market value of the said securities, 
as a whole, suffer any decline. The undersigned hereby 
give to the Bank a lien for the amount of all such obligations 
and liabilities upon all the property or securities now or at 
any time hereafter given unto or left in the possession of the 
Bank by the undersigned, whether for the express purpose 
of being used by the Bank as collateral security, or for any 



174 LOANS AND INVESTMENTS 

other or different purpose, and also upon any balance of 
the deposit account of the undersigned, or any of them, 
with the Bank. 

On the non-performance of this promise, or upon the non- 
payment of any of the obligations or liabilities above men- 
tioned, or upon the failure of the undersigned, forthwith, 
with or without notice, to furnish satisfactory additional 
securities, or to make payments on account, in case of de- 
cline, as aforesaid, or in case of insolvency, bankruptcy, or 
failure in business of the undersigned, or any of them, then 
and in any such case, all obligations and liabilities, direct 
or contingent, of the undersigned and each of them, shall 
forthwith become due and payable without demand or 
notice ; and full power and authority are hereby given to the 
Bank to sell, assign, and deliver the whole of the said se- 
curities, or any part thereof, or any substitutes therefor, or 
any additions thereto, or any other securities or property 
given unto or left in the possession of the Bank by the 
undersigned, whether for the express purpose of being used 
by the Bank as collateral security, or for any other or differ- 
ent purpose, or in transit to or from the Bank, by mail or 
carrier, for any of the said purposes, at any broker's board, 
or at public or private sale, at the option of the Bank, with- 
out either demand, advertisement or notice of any kind, all 
of which are hereby expressly waived. At any such sale, 
the Bank may itself purchase the whole or any part of the 
property sold, free from any right of redemption on the part 
of the undersigned, which is hereby waived and released. 
In case of any sale or other disposition of any of the prop- 
erty aforesaid, after deducting all costs, or expenses of every 
kind for collection, sale or delivery, the Bank may apply the 
residue of the proceeds of the sale or sales so made, to pay 
one or more or all of the said obligations or liabilities to it, 
whether then due or not due, making proper rebate for inter- 
est on obligations or liabilities not then due, and returning 






LOANS AND INVESTMENTS 175 

the overplus, if any, to the undersigned, who agree to be 
and remain liable, jointly and severally, to the Bank for any 
deficiency arising upon such sale or sales. The undersigned 
do hereby authorize and empower the Bank, at its option, at 
any time, to appropriate and apply to the payment and 
extinguishment of any of the obligations or liabilities, here- 
inbefore referred to, whether now existing or hereafter con- 
tracted and whether then due or not due, any and all moneys 
now or hereafter in the hands of the Bank, on deposit or 
otherwise, to the credit of or belonging to the undersigned, 
or any of them. 

The Bank may assign or transfer this instrument and may 
deliver the said collateral security or any part thereof to 
the transferee or transferees, who shall thereupon become 
vested with all the powers and rights above given to the 
Bank in respect thereto; and the Bank shall thereafter be 
forever relieved and fully discharged from any liability or 
responsibility in the matter. No delay on the part of the 
holder hereof, in exercising any rights hereunder, shall 
operate as a waiver of such rights. 

On the back of collateral notes and collateral loan 
agreements some such provision as the following 
may be printed: "In consideration of one dollar 
paid to the undersigned, and of the making, at the 
request of the undersigned, of the loan evidenced 
by the within note, the undersigned hereby jointly 
and severally guarantee to The Institute Bank of 
New York, its successors, indorsees or assigns, the 
punctual payment, at maturity, of the said loan, 
and hereby assent to all the terms and conditions 
of the said note, and consent that the securities for 
the said loan may be exchanged or surrendered 
from time to time, or the time of payment of the 



176 LOANS AND INVESTMENTS 

said loan extended, without notice to or further 
assent from the undersigned, who will remain bound 
upon this guaranty, notwithstanding such changes, 
surrender or extension. 5 ' 



CHAPTER V 



Seasonal Demands for Money 

160. SEASONAL MOVEMENTS IN MONEY 
MARKETS.— The demand for money in the United 
States is seasonal in character. This fact is largely 
due to conditions pertaining to the marketing of 
agricultural crops. Seasonal demands for money 
vary to some extent in different sections of the 
country in accordance with local conditions, but 
the seasonal swings manifested in New England, 
the Middle States, and the district tributary to 
Chicago, are essentially the same. Since this terri- 
tory includes New York City, the country's domi- 
nant money market, it may be taken as typical. 
This territory shows five important seasonal periods 
which may be briefly described as follows: 

(1) Throughout January and during the early 
part of February there is normally a pronounced 
"easing up" of the money market. By the fore 
part of January the crop-moving demand for money 
in the West and South is over and the return flow 
of cash is at its height. There is a natural reaction 
— in part psychological — which results from the 
relaxing of the heavy strain on the money market 
incident to January 1 settlements and to the pass- 
ing of the holiday season. At this time freight 
traffic, both on the railroads and the inland water- 
ways, is relatively small. 

177 



178 LOANS AND INVESTMENTS 

(2) The next seasonal movement is the "spring 
trade revival," beginning about the middle of Feb- 
ruary and extending until the latter part of March 
or the fore part of April (in some years a week or 
so later). This recovery is stimulated by the cheap 
money prevailing during the preceding period, rail- 
road traffic is released from the incubus of cold 
weather and snow, and the inland waterways are 
opened up; on April 1 comes the demand for large 
interest and dividend settlements, and in this period 
comes the spring demand of agriculturists for the 
planting of the crops. 

(3) The third important seasonal movement is 
the weakening money market of the late spring, 
followed by the summer depression. This period 
extends from the fore part or middle of April to 
the fore part of August. It is interrupted by a 
temporary reaction about July 1, the time of semi- 
annual settlements. This period shows the natural 
reaction from the high rates of the preceding 
period, the anticipation and later the realization 
of the hot months of summer comprising the vaca- 
tion period, the lessened demand for funds in the 
middle West after the planting of the crops, and 
the resulting return of cash to New York. The 
declining and cheap money market at this time, 
which finds expression in such phenomena as large 
bank reserves, low percentage of loans to deposits, 
low interest rates, gold exportations, and high 
security prices, is to some extent self-corrective. 



LOANS AND INVESTMENTS 179 

(4) The crop-moving period is the fourth 
period. This period, the discounted beginning of 
which is evidenced by the upward turn of inter- 
est rates on sixty to ninety day commercial paper 
and four months' time paper as early as the first 
week in July, may perhaps best be dated from the 
first week in August, when call rates begin their 
upward movement and when bank reserves begin 
their decline. Under the pressure of the crop- 
moving demand for cash in the West and South, 
bank reserves are depleted and the money market 
tightens rapidly until about October 1. 

(5) The fifth and last seasonal period in the 
New York money market extends from about the 
first week in October to the opening of the new 
year. It is a period of considerable uncertainty 
and of many minor fluctuations, but the demand 
for moneyed capital continues large until after the 
holiday season and January settlements. The 
westward movement of cash falls off rapidly in 
November and December, and by the latter month 
the return flow has set in. The southward move- 
ment declines in November, but shows some signs 
of increasing temporarily in December. Gold im- 
ports reach a low point in December. 

Doubtless the Federal Reserve System will exer- 
cise a large influence in the direction of lessening 
the extent of these seasonal fluctuations, and pos- 
sibly also some influence upon the delimitations of 
the periods themselves. Seasonal demands for 



180 LOANS AND INVESTMENTS 

money, however, are organic, and while new bank- 
ing conditions may diminish their acuteness, the 
problem of periodical variations promises to con- 
tinue to complicate the banking business. 

161. SEASONAL VARIATIONS IN NEW 
ENGLAND. — A comprehensive study of the causes 
and effects of seasonal demands for money was 
made a few years ago by Professor E. W. Kem- 
merer of Princeton University, and published by 
the L jnetary Commission. According to Professor 
Kemmerer, currency movements to and from New 
England are principally to and from the Eastern 
States (almost entirely New York City). In Janu- 
ary there is a strong movement of cash from New 
England to New York City, in part the result of 
large purchases of cotton by manufacturers in 
Massachusetts and vicinity, and in part probably 
the result of the return flow of cash to the banks 
after the holiday demand and of the call for New 
York remittances in settlement of holiday pur- 
chases. February shows a comparatively small 
movement of cash in both directions. March and 
April are characterized by heavy shipments of cash 
from New York City to New England, caused in 
part by the heavy demand for remittances to Massa- 
chusetts manufacturers by western and southern 
jobbers and in part probably by the spring needs 
of New England farmers. May, June and July 
appear to be moderately inactive months, so far 
as currency movements between New England and 



LOANS AND INVESTMENTS 181 

the Eastern States are concerned, with some flow 
of cash in both directions, but no great preponder- 
ance in one direction over the other. For August, 
September and October the movement is toward 
New England. The August movement is at least 
in part due to the preparation on the part of New 
England bankers for an anticipated difficulty in 
getting funds from New York in the autumn, when 
New York banks are subject to such large calls 
from the West and South. The September and 
October movement is largely due to remittances 
made at that time by jobbers in the West and South 
in settlement of accounts for the purchase of shoes, 
dry goods, and other articles of New England 
manufacture. For November and December cash 
tends to flow from New England to New York City, 
in response to the large purchases of cotton by New 
England manufacturers during these months, the 
drafts upon the mills for cotton coming mainly 
through New York. 

162.— SEASONAL VARIATIONS IN THE 
MIDDLE WEST.— New York exchange in Chi- 
cago is normally high throughout January, and 
there is a strong movement of cash from Chicago 
to New York at that time. The crop moving and 
holiday demand being over, money tends to be rela- 
tively cheap in Chicago, and flows to New York 
City, where it is absorbed somewhat in speculative 
activity and in the higher security prices which 
normally rule the latter part of January and the 



182 LOANS AND INVESTMENTS 

fore part of February. From the last of January 
to the fore part of March, New York exchange 
tends to fall, and shipments of cash from Chicago 
to the Eastern States are very small. During this 
period the demand for money in Chicago is in- 
creased by the anticipated opening of navigation 
on the Great Lakes, the demand on the part of 
western bankers for currency to meet the spring 
needs of farmers, and by the fact that the first of 
March in many sections of the Middle West is 
the commonest time for making settlements of 
interest and principal on farm mortgages. New 
York exchange reaches its minimum (for this part 
of the year) early in March, and then advances 
rapidly until it reaches its maximum for the year 
the latter part of May. It then continues at a 
high level until early in July, when the crop mov- 
ing demands begin to make themselves felt. About 
the first of July New York exchange begins to fall 
in response to the crop moving demand, declining 
rapidly, with minor interruptions, until early in 
September, and then maintaining a low level until 
the fore part of November. There is a strong 
movement of currency from the Eastern States to 
Chicago in August, September and October, reach- 
ing its maximum for the year in October. During 
the last seven or eight weeks of the year, the crop 
moving demand having subsided, New York ex- 
change tends to rise, and the return movement of 
cash to the East begins. The seasonal movements 



LOANS AND INVESTMENTS 183 

in New York exchange in St. Louis are similar to 
those in Chicago. The seasonal currency move- 
ments between Chicago and the Eastern States are 
fairly representative of those between the Middle 
Western States as a whole and the Eastern States. 
163. MIDDLE WEST AND SOUTHERN 
STATES. — Currency movements between the Mid- 
dle Western States and the Southern States are 
large, and afford valuable evidence as to the sea- 
sonal variations in the demand for money in the 
two sections compared with each other. January 
is clearly the month of largest receipts by the 
Middle Western States from the Southern States. 
This January movement is apparently the return 
movement of cash after the crop moving demand 
in the South has subsided, and it is largely to St. 
Louis and Chicago— principally the former. While 
there is a pronounced falling off in February in 
this flow of cash to the Middle Western States, 
it continues, nevertheless, in substantial amounts 
for several months, with May as the second highest 
month of the year. Beginning about the first of 
May, the banks in the winter wheat section are 
called upon to finance the winter wheat crop, and 
this fact may explain in part the strong movement 
of cash from the South in May. Receipts of the 
Middle Western States from the Southern States 
decline rapidly from June to November, and, con- 
temporaneously, there is an increasing movement 
of cash in the opposite direction, culminating in 



184 LOANS AND INVESTMENTS 

October, and apparently showing that, despite the 
great needs of the Middle West for cash in the 
crop moving season, the needs of the South are 
sufficiently greater to make the flow of cash 
strongly southward from the Middle West. Sep- 
tember and October have been found to be clearly 
the months of largest movements of cash from the 
Middle Western States to the Southern States, 
while January has been found to be the month of 
largest movement of cash in the opposite direction. 
November and December show considerable move- 
ments of cash in both directions, and may perhaps 
best be classed as transitional months. 

164. SEASONAL VARIATIONS IN THE 
SOUTH. — New York exchange in New Orleans 
shows the usual advance during the fore part of 
January, in response to the demands for New York 
funds for investment during the slack season in 
the South. As the funds are transferred, there is 
naturally a decline (extending from about the third 
to the eighth week), after which exchange exhibits 
no important seasonal movements until about the 
middle of May. From then until about the middle 
of June exchange tends to advance. During the 
next three weeks there is a reaction, followed by 
a temporary advance, extending from about the 
middle of July to the middle of August. The 
southern crop moving demand begins in earnest 
about the middle of August, when bills against 
crop shipments are offered in large quantities, and 



LOANS AND INVESTMENTS 185 

exchange is forced down rapidly and almost con- 
tinuously until the minimum rates of the year are 
reached in the fore part of November. The crop 
moving demand having reached its high point about 
the forty-fifth week, the return flow of cash from 
nearby agricultural communities to New Orleans 
sets in, money becomes more plentiful, and ex- 
change rates advance, the upward movement being 
expedited by the holiday demand for New York 
exchange and by the demand incident to January 
settlements. January is the month of strongest 
movements of cash from the South toward the 
Eastern States. The five months, February to 
June, inclusive, are months of moderate move- 
ments of cash toward the Eastern States. Begin- 
ning with July, there is an increasing movement 
in the opposite direction, culminating in September 
and October, when the crop moving demand is at 
its height. In November and December there is 
considerable movement in both directions, and 
those months may best be classed as transitional 
months between the southward crop moving flow 
of September and October and the northward 
return flow of January. 

165. SEASONAL VARIATIONS ON THE 
PACIFIC COAST.— From the beginning of Janu- 
ary until about the first of March, New York 
exchange in San Francisco rises rapidly. January 
and February are months of relatively large ship- 
ments of cash from San Francisco to the Eastern 



186 LOANS AND INVESTMENTS 

States. Among the principal causes may be men- 
tioned the fact that advances which have been made 
for the movement of general crops are being repaid 
rapidly, the demand for eastern remittances to pay 
bills incurred for holiday purchases, and the desire 
of local taxpayers to get movable funds out of the 
State the latter part of February before the tax 
returns of the first Monday in March are made to 
the assessors. From the fore part of March to the 
fore part of June, the general tendency of New 
York exchange is upward, although there are minor 
interruptions. March, April and May are months 
of comparatively small shipments of cash by San 
Francisco to the Eastern States, and the shipments 
in the opposite direction are of little importance 
During the latter part of June, New York exchange 
temporarily advances, probably in response to 
demands for remittances east to meet July settle- 
ments. Exchange rates decline from about the 
first week in July to the fore part of September. 
This decline is not sufficient to bring about the 
shipment of cash to San Francisco from the Eastern 
States. It is, however, sufficient to reduce the east- 
ward flow of cash. The decline is probably due to 
the large amount of eastern credits available locally 
at this time from the shipments of California 
products, especially green fruits, to eastern points. 
From about the middle of September to the latter 
part of October, New York exchange tends to rule 
at near par. During this period the outward move- 



LOANS AND INVESTMENTS 187 

ments of grain, green fruit, and fish, tend to force 
exchange down, while the facts that this is the 
quarter of large receipts of gold from Alaska, mak- 
ing it a period of large receipts of gold bullion at 
the mint, and that the San Francisco mint makes 
returns for this gold in gold coin or New York 
exchange at the option of the owner of the bullion, 
tend to keep New York exchange at par. Exchange 
falls rapidly from the latter part of October to 
about the first of December, when it reaches the 
lowest point of the year. Shipments of cash be- 
tween San Francisco and the Eastern States are 
unimportant during this period. November and 
December, however, are the months of largest 
transfers of cash to San Francisco. The fall in 
exchange at this time appears to be due primarily 
to the outward movement of dried fruits and to the 
fact that this is the active part of the northern grain 
season. The low point of the year is reached about 
the last week in November, when the tax collector 
for the city and the county of San Francisco has 
been accustomed to withdraw large sums of actual 
coin from circulation, and to lock much of it up 
in the vaults of the city hall. 

166. SEASONAL VARIATIONS IN FOR- 
EIGN EXCHANGE. — Sterling exchange rates 
normally rise throughout January and the fore part 
of February. Gold movements to and from the 
United States at this time are generally not large, 
but the tendency is toward exportation. In Lon- 



188 LOANS AND INVESTMENTS 

don the money market tends to be reasonably 
strong in January, weakening, however, in Febru- 
ary. From the latter part of February until the 
latter part of March, the tendency of sterling ex- 
change rates is slightly downward. March is a 
moderately weak month in the London money 
market. Sterling exchange in New York advances 
rapidly from the latter part of March until the 
middle of June, reaching its highest point of the 
year in June. For April, May and June the move- 
ment of gold is outward, the average net exporta- 
tions reaching their highest figures for the year in 
May and June. The London market appears to 
"ease up" considerably at this time. Sterling rates 
continue high through July, though declining 
slighty, and then decline rapidly under the influence 
of cereal and cotton bills and of the crop moving 
demand for money, until they reach their lowest 
point of the year about the first week of October. 
The months of October, September and November 
(in the order named) are the months of largest 
net gold importations. In the London money mar- 
ket the fall months are commonly spoken of as the 
period of the "autumnal pressure" or the "autumnal 
drain." From the fore part of October until the 
latter part of November, sterling exchange tends 
to move upward, and from the latter date until the 
end of the year it is very uncertain. Gold importa- 
tions are usually much smaller in December than 
in November. Recent important developments in 



LOANS AND INVESTMENTS 189 

the use of finance bills, by which funds are bor- 
rowed by American bankers in Europe, especially 
in London, on collateral security, usually in the 
form of stocks and bonds, have had an important 
influence upon the sterling exchange market, tend- 
ing to level somewhat the seasonal fluctuations. It 
has, however, by no means destroyed the normal 
seasonal swing of the exchange market. 

167. SEASONAL VARIATIONS IN PRICES 
OF BONDS.— On theoretical grounds it would be 
expected that periods of greatly increasing demand 
for money, like the crop moving period, would tend 
to cause lower prices for bonds, and that a period 
of greatly decreasing demand, like that of mid- 
summer, would tend to cause higher prices. In the 
fall months a greater burden of work is imposed 
upon the money in circulation, and unless its rate 
of turnover increases the same amount will not do 
the work except at a lower level of prices. The 
extra burden of exchange work is carried in part 
by the expansive power of deposit currency, but 
even deposit currency must be supported by cash 
reserves, and the need of cash for crop moving 
purposes, which results in the westward and south- 
ward movement of reserve money, limits the ex- 
pansive power of deposit currency. For the pur- 
pose of testing the truth of such reasoning, "and 
interest'' quotations were compiled and index num- 
bers computed by Professor Kemmerer for the 
prices of twenty-seven railroad bonds for periods 



190 LOANS AND INVESTMENTS 

ranging from nine to nineteen years. These figures 
were then combined into a composite for all bonds 
for all years, each point in the composite represent- 
ing three hundred and ninety-three or three hun- 
dred and ninety-four bond years. The evidence 
afforded by these figures shows the following 
seasonal tendencies: 

(1) There is a strong tendency for bond prices 
to rise from the beginning of the year until about 
the first week in February, a period during which 
the money market has been found to be almost 
invariably declining and weak. From the first to 
the fifth week of the year the average price of all 
twenty-seven bonds rose from 98.99 to 99.79, the 
average index number of prices rising from 48.1 
to 60.9. For twenty-six of the twenty-seven bonds 
the average price was higher for the fifth week than 
for the first, and for two hundred and sixty-eight 
of the three hundred and ninety-four bond years 
the price for the fifth week was higher. In addition 
to the influence of the weak money market at this 
period, it should be noted that after January (and 
also July) disbursements of interest and dividends, 
there are considerable amounts of funds seeking 
reinvestment. 

(2) The second seasonal period extends from 
the fore part of February to the latter part of 
March. It is a period during which the tendency 
of prices is downward, and a period of increasing 
demand for loanable capital. The average price 



LOANS AND INVESTMENTS 191 

of the twenty-seven bonds fell from 99.79 for the 
fifth week to 99.02 for the eleventh week, the 
average index number falling from 60.9 to 51.1. 
For twenty-five of the twenty-seven bonds the 
average price was lower for the eleventh week than 
for the fifth, and the price was lower for the eleventh 
week in two hundred and ninety of the three hun- 
dred and ninety-four bond years. 

(3) The third seasonal tendency is for bond 
prices to rise from the latter part of March until 
the fore part of May, and to be comparatively high 
from then until about the middle of June — a ten- 
dency in substantial harmony with the money mar- 
ket movements of this season of the year. The 
average price of the twenty-seven bonds rose from 
99.02 for the eleventh week to 99.56 for the 
twenty-fourth week, the average index number 
rising from 51.1 to 56.7. For twenty-two of the 
twenty-seven bonds the average price was higher 
for the twenty-fourth week than for the eleventh, 
and of the three hundred and ninety-three bond 
years, two hundred and nine showed higher prices 
for the twenty-fourth week than for the eleventh. 

(4) For the period from the middle of June 
until early September the evidence is contra- 
dictory, but on the whole seems to point to a ten- 
dency for prices to be moderately high. 

(5) Beginning near the middle of September, 
bond prices tend downward until about the middle 
of October. The average price of all twenty-seven 



192 LOANS AND INVESTMENTS 

bonds fell from 99.49 for the thirty-sixth week to 
99.11 for the forty-first, and the average index 
number fell from 54.9 to 50. For twenty-one of 
the twenty-seven bonds the average price was lower 
for the forty-first week than for the thirty-sixth, 
and the price was lower for the forty-first week 
in two hundred and thirty-six of the three hundred 
and ninety-four bond years. 

(6) From about the middle of October, after 
the heaviest part of the crop moving demand for 
money is over, until early December, bond prices 
show an upward tendency. The average price of 
all bonds rose from 99.11 for the forty-first week 
to 99.75 for the forty-ninth week, the average index 
number rising from 50 to 56.3. Twenty-five of the 
twenty-seven bonds showed higher average prices 
for the forty-ninth week than for the forty-first, 
and of the three hundred and ninety-four bond 
years, two hundred and forty-three showed a higher 
price for the forty-ninth week. In addition to the 
relaxation of the crop moving demand for money 
at this time, another factor is the tendency of 
dealers to accumulate bonds in anticipation of an 
increasing demand rising from the dividend and 
interest disbursements of January 1. The latter 
part of December is a transitional period for bond 
prices, as it has been found to be for many other 
money market phenomena, the tendency being 
downward from the forty-ninth to the fifty-first 
week, and then upward for the fifty-second week. 



LOANS AND INVESTMENTS 193 

The average price of all twenty-seven bonds fell 
from 99.75 for the forty-ninth week to 99.39 for 
the fifty-first week, and then rose to 99.58 for the 
fifty-second. The corresponding average index 
numbers were, respectively, 56.3, 52.2 and 55. For 
twenty- three of the twenty-seven bonds the average 
price was lower for the fifty-first week than for the 
forty-ninth. The price was lower also for the fifty- 
first week than for the forty-ninth in two hundred 
and thirty-nine of the three hundred and ninety- 
four bond years. The tendency toward instability 
in December is shown by the fact that December 
had both more maximum annual prices and more 
minimum annual prices than any other month of 
the year. 

It may be concluded that the extent of the sea- 
sonal variations in bond prices is usually not great, 
but that the percentage is large enough in the abso- 
lute to amount to many million of dollars annually. 
The seasonal movements are for the most part not 
very pronounced in their regularity, but on the 
whole tend to conform to the normal seasonal 
swing of the money market. 

168. SEASONAL STRAINS ON BANK RE- 
SERVES. — Seasonal demands for money have a 
direct influence on bank reserves. The enormous 
sum of twenty billion dollars, more or less, is the 
sum of individual deposits in American banks, 
exclusive of savings banks. Of this large sum 
approximately one-half consists of individual de- 



194 LOANS AND INVESTMENTS 

posits subject to check without notice. Most of 
the remainder consists of various kinds of savings 
deposits, a considerable part of which are legally 
payable on demand, and most of which are actually 
so payable as a matter of banking policy and prac- 
tice. Such total individual deposits represent over 
five times the total money in circulation, while that 
part of them which is subject to withdrawal 
without notice represents probably at least three 
times the country's total monetary circulation. 
The obligation of banks to pay their demand 
deposits on demand is so exacting that a failure to 
do so is an act of insolvency, and may be made the 
occasion of forcing the guilty bank to close its 
doors. As regards a large proportion of their sav- 
ings deposits, commercial banks may legally exer- 
cise the privilege of requiring thirty or sixty days' 
notice for withdrawal. They seldom do so, how- 
ever, since refusal to pay savings deposits on 
demand impairs public confidence in any bank, and 
is likely to cause a run on its demand deposits. 

169. ADEQUACY OF RESERVES.— The 27,- 
000 commercial banks, holding approximately ten 
billion dollars of demand deposits, according to re- 
cent statistics, have in their vaults less than one and 
a half billions in cash, less than one-third of which is 
"legal tender money." Their total cash reserves 
therefore average less than 16 per cent, of their in- 
dividual deposits subject to check without notice, 
and but 7.6 per cent, of their total individual de- 



LOANS AND INVESTMENTS 195 

posits. Subject to the requirements of law, which in 
the United States usually compels banks to keep a 
certain minimum reserve against deposits, and 
subject also in some cases to minimum reserve 
rules of the local Clearing House Association, each 
bank must decide, according to the nature of its 
own business, the characteristics of its own cus- 
tomers — their habits and prejudices — and accord- 
ing to the varying states of the money market, how 
large a cash reserve it will keep. Most foreign 
countries do not impose by law minimum reserve 
requirements against bank deposits. It is the 
almost universal practice, however, in the United 
States. Such requirements have been imposed by 
the national government since the passage of the 
National Banking Act in 1863, and are also imposed 
by the banking laws of nearly all the States. Inas- 
much as reserve money in vaults yields no direct 
profit to the bank, the desire for profits continually 
exercises pressure to reduce the cash reserves to 
a minimum. On the other hand, profits in the long 
run require that the bank shall enjoy the confidence 
of the public; and a reputation for strength and 
conservatism is to a bank a great asset. The main- 
tenance of a reserve at all times fully adequate to 
meet demands is a large factor in building up a 
bank's reputation, and, as many American bankers 
can testify after a period of money stringency, such 
a reserve is an important factor in the peace of 
mind of bank officials. A reserve, however, that 



196 LOANS AND INVESTMENTS 

would be adequate for one bank may be grossly 
inadequate for another; while a reserve that is 
adequate for a bank at one season of the year may 
be far from adequate for the same bank at another 
season. 

170. LEGAL TENDER AND OTHER RE- 
SERVE CREDITS.— Bank deposits are payable 
in legal tender money, and legal tender money 
alone if the depositor insists. Therefore, narrowly 
speaking, the term bank reserve might be limited 
to legal tender money in the possession and owner- 
ship of the bank. Inasmuch, however, as certain 
other kinds of money, e. g., gold certificates, silver 
certificates, National bank notes and Federal Re- 
serve notes, are everywhere accepted by the public 
in final payment of debts, and are redeemable in 
legal tender money on demand, by an institution 
of unquestioned financial stability, the United 
States Government, it is reasonable from the eco- 
nomic point of view — not always the legal point 
of view — to extend the term to cover such kinds 
of money. Furthermore, in countries where there 
is a central bank, as in France and Germany, or 
a group of central banks as in the Federal Reserve 
System of the United States, with liberal powers 
of bank note issue, and with public responsibilities 
in the line of rediscounting, and of otherwise con- 
serving the national money market, it seems 
reasonable, from the economic point of view, to 
extend the term reserve so as to cover not only 



LOANS AND INVESTMENTS 197 

the bank notes of the central banks, but also 
bankers' non-interest-bearing demand deposits in 
these central banks. In France, Germany and 
England bank notes of the central bank are legal 
tender; and bank reserves, or "cash balances," as 
they are commonly called, always mean "cash on 
hand and in the central bank." When a legal mini- 
mum reserve exists, as in the United States, it is 
a debatable question whether it is sound public 
policy to permit bank notes and bankers' deposits 
in the central bank to be included to an unlimited 
extent in the funds constituting the legal minimum. 
171. SECONDARY RESERVES AND 
THEIR CHARACTER.— Having decided upon the 
size of its normal reserves, i. e., a fair working 
balance plus a reasonable "factor of safety," the 
bank seeks to invest the remainder of its funds 
where they will bring the largest returns consist- 
ent with safety, and with the future development 
of the bank's business. Since the great bulk of 
a commercial bank's liabilities to its customers are 
demand liabilities, and since those which are not 
demand are usually payable on very short notice, 
i. e., thirty to sixty days, the bank in making its 
investments is constrained to put a substantial part 
of its funds in quick assets, investments which can 
be turned into cash promptly and without much 
loss in time of need. This type of investment is 
called a "secondary reserve," because, following 
the cash on hand, it is a "second line of defense" 



198 LOANS AND INVESTMENTS 

in case of exceptional demands. Strictly speaking 
it is not a "reserve" at all, but a form of interest- 
yielding investment. These secondary reserves 
may consist of innumerable forms of investments; 
they may be interest-bearing demand deposits in 
other banks, self -liquidating commercial paper ar- 
ranged so that the maturities come along at short 
intervals, commodity paper secured by cotton, grain 
or other staple commodities, call or time loans on 
stock exchange collateral; securities purchased, 
especially listed railroad and municipal bonds, and 
many other kinds of evidence of indebtedness. 
Whatever form these investments take, the banker 
in selecting them submits them to a three-fold test: 
(1) Marketability in times of emergency, (2) Safety, 
and (3) Income yield. 

172. MARKETABILITY IN EMERGEN- 
CIES. — The first requirement of a secondary re- 
serve is exchangeability in times of emergency 
for money, which is itself the ultimate means 
of payment and the most highly exchangeable 
of economic goods. The emergencies to be met 
may be runs on the bank, flurries in the local 
money market; the fairly regularly recurring 
periods of seasonal strain, like the crop moving 
period in the fall or the period of the "spring re- 
vival ;" or it may be one of the great financial crises 
that strike us occasionally. Whatever may be the 
cause of the emergency, the secondary reserve is 
the bank's insurance fund to protect it against em- 



LOANS AND INVESTMENTS 199 

barrassment and insolvency. When the demand 
comes, if the secondary reserve can be turned 
quickly into cash, i. e., into a primary reserve, the 
bank keeps open its doors and conserves its reputa- 
tion; if it cannot be transmuted quickly into cash, 
the bank suspends cash payments and usually closes 
its doors either temporarily or permanently. Even 
if later it meets its obligations and resumes busi- 
ness, it will have suffered a serious impairment in 
that great banking asset, reputation for financial 
stability. The secondary reserve, like the second 
line of defense in time of battle, when it is called 
upon to be the first line, is first of all expected to 
meet the attack, and meet it effectively. If it can 
do so without serious loss, so much the better, but 
loss or no loss, it should meet it. To this end it 
must above all else be "emergency-marketable." 

173. SAFETY OF INVESTMENT. — It is 
self evident that a bank's secondary reserves should 
be safely invested. Banks want interest, but they 
do not wish to lose the principal. This requirement 
of safety is important in itself, and is a corollary 
of the preceding requirement of marketability in 
times of emergency. For, while unsafe and specu- 
lative securities may have active markets in pros- 
perous times, they have little market in times of 
crisis; and it is then that the concerns that issue 
them go to the wall in large numbers. Not all 
intrinsically safe securities are marketable in 
stringent times, but intrinsically safe securities 



200 LOANS AND INVESTMENTS 

alone are highly marketable. Only assets that rest 
upon "bed rock" values can be depended upon as 
secondary reserves. 

174. INCOME YIELD OF INVESTMENT. 
— In order of importance the third criterion of a 
good secondary reserve is income yielding capacity. 
Although the banking business is in a large measure 
"affected with a public interest," and bankers are 
in a high degree "public trustees," it is still true 
that the chief motive power that drives the modern 
banking machinery is the desire for financial profit. 
A secondary reserve is primarily an emergency in- 
vestment, but it is none the less an investment, and 
the threatened emergencies which influence its 
character are of infrequent occurrence and usually 
of brief duration. The rate of "fair weather" profit, 
therefore, is an important consideration even in the 
formation of a secondary reserve. The profits, 
however, should not be viewed with a near-sighted 
vision. It is as true of secondary reserve invest- 
ments as of other investments of bank funds, that 
the successful banker is the man with foresight — 
the banker "with a telescope in his head" — who 
often passes by opportunities for good immediate 
profits in order to seize opportunities to strengthen 
and broaden his clientele for future business. 

175. COMMERCIAL PAPER IN EUROPE. 
— For many years the chief secondary reserve in the 
banks of Europe has been commercial paper, princi- 
pally the commercial acceptance, in which the seller 



LOANS AND INVESTMENTS 201 

of merchandise draws a bill of exchange on the 
buyer at, say, sixty or ninety days' sight, the buyer 
of the merchandise accepting the bill, and later pay- 
ing it at maturity out of the proceeds of the sale of 
the merchandise. The seller of the merchandise ordi- 
narily discounts this paper at his bank. Such com- 
mercial bills bearing the names of large and reliable 
business houses become ideal secondary reserves 
in the portfolios of banks. They bear at least two 
names, i. e., that of the drawer and that of the 
drawee, and often in addition the name of one or 
more endorsers. They normally carry on their 
face, or on documents attached, evidence of a com- 
mercial transaction which is closed; the drawee, 
i. e., the buyer of the goods, having accepted them 
and obligated himself to pay for them a definite sum 
of money at a specified date. These bills are ordin- 
arily drawn for current merchandising transactions 
and bear evidence that they are not for capital 
investments. They are self liquidating in that the 
sale of the goods by the drawee provides the funds 
with which to pay the bill, and in that the goods 
are ordinarily turned over rapidly. In view of the 
fact that it is the drawers of the bills (i. e., the 
sellers of the merchandise) who discount them at 
the bank, not the drawees (i. e., the buyers of the 
merchandise and the ones who are to pay the bills), 
and of the further fact that the bills often pass 
through several hands in the open market before 
their maturity, these bills usually are paid promptly. 



202 LOANS AND INVESTMENTS 

High grade paper of this kind is always acceptable 
for rediscount at the great central banks of Europe, 
and the proceeds of the rediscounting operation, 
when left on deposit or taken in the form of bank 
notes, serve as primary reserves. The great central 
banks feel a public moral responsibility to rediscount 
at their official discount rates such paper in practi- 
cally unlimited quantities when the public interest 
seems to demand it. The fact that this paper is re- 
discountable at the central bank makes it also sal- 
able in the open market, with the result that good 
grade commercial bills in many parts of Europe are 
in time of peace almost as dependable in emergencies 
as is cash in vault. A bank with a reasonable amount 
of such bills in its portfolio has an ideal secondary 
reserve. 

176. SITUATION IN FRANCE.— Upon this 
subject a brief reference to the testimony given 
to members of the National Monetary Commission 
by bankers in France will be useful. Officers of 
the Credit Lyonnais, one of the leading banks of 
France, testified as follows: 

Question — "Does the Bank of France rediscount 
bills for the other banks in France?" 

Answer — "The Bank of France rediscounts all 
bills when the person presenting the bill is admitted 
to discount and when the bills have the necessary 
three signatures, have less than three months to 
run, and are payable in cities where the bank has 
a branch. It is not legally obliged to discount all 



LOANS AND INVESTMENTS 203 

bills presented, but, as a matter of fact, nobody has 
ever complained of its way of proceeding." 

Question — "You regard that item of bills dis- 
counted as your practical reserve because of your 
ability to rediscount the bills at the Bank of 
France? 

Answer — "Yes; bills discounted and cash are, 
for an establishment such as ours, the most essen- 
tial part of our liquid assets." 

The founder of the Credit Lyonnais declared 
that if the Bank of France did not exist he would 
close the Credit Lyonnais in times of crisis. Ac- 
cording to the estimate of the Governor of the 
Bank of France, about 70 per cent, of the paper 
held by the bank bore the signature of some bank 
as one of the endorsers. 

177. SITUATION IN OTHER EUROPEAN 
COUNTRIES. — A similar situation exists in 
Germany and most other continental European 
countries as regards the dependence of the com- 
mercial banks upon the central bank for obtaining 
emergency funds by rediscounting commercial 
paper. In England the situation is somewhat 
different in that the joint-stock banks rarely re- 
discount at the Bank of England. However, these 
banks loan funds extensively to discount and brok- 
erage houses, and, when pressure comes for funds, 
they call these loans, with the result that the dis- 
count and brokerage houses resort to the Bank of 
England for funds. Indirectly, therefore, the result 



204 LOANS AND INVESTMENTS 

is much the same as on the continent. Reserve 
money in England is "cash on hand and in the Bank 
of England," and the statements of most banks 
do not differentiate the two items. The Bank of 
England always stands ready to rediscount prime 
commercial paper and transmute it into reserves. 
In Europe generally, therefore, prime commercial 
paper is the chief dependence for a secondary re- 
serve, and it meets in a high degree the three re- 
quirements of a good secondary reserve, viz., 
"emergency marketability," safety, and good in- 
come yield. 

178. SITUATION IN THE UNITED 
STATES.— The situation in the United States is 
very different, although recent developments under 
the Federal Reserve System are slowly changing 
the American situation in the direction of that of 
Europe. In tHe United States, commercial paper, 
which consists chiefly of one name promissory 
notes, has not until recently been very satisfactory 
as a secondary reserve. The absence of any central 
bank in this country for a couple of generations prior 
to 1914, denied to American banks the privilege of 
a practically unlimited market for the rediscount 
of this commercial paper, a privilege which has so 
long been enjoyed by European banks. Further- 
more, the provisions of our National Banking Law 
denying to National banks the privilege of estab- 
lishing branches, and provisions in the banking 
laws of many of our States either prohibiting en- 



LOANS AND INVESTMENTS 205 

tirely the establishment of branches by State banks, 
or imposing heavy restrictions upon their establish- 
ment, has prevented the growth in this country 
of many large banks. Our bond-secured bank note 
system has been another inhibiting influence. 
America is unique among the advanced countries 
of the world in its great number of small and inde- 
pendent banks, the chief business of most of which 
is limited to a small community. There accord- 
ingly developed no large commercial banks which 
could be depended upon to provide a wide market 
for the discount of commercial paper. The Na- 
tional Bank Act as interpreted by the courts pre- 
vented National banks from accepting time bills 
drawn upon them, and bank acceptances were not 
permitted under the banking laws of most of the 
States. Accordingly, prior to the inauguration of 
the Federal Reserve System, the bank acceptance, 
which is such a highly marketable type of paper 
in Europe, was almost unknown in this country. 
Aside from the paper of a few large business 
houses, which in recent years has been widely 
marketed throughout the country by note brokers, 
American commercial paper was essentially local 
paper. 

179. LACK OF COMMERCIAL PAPER 
MARKET.— Nothing that could be called prop- 
erly a commercial paper market existed in the 
United States. A petty amount of rediscounting, 
it is true, was done for country banks by a few 



206 LOANS AND INVESTMENTS 

large banks; also a considerable amount of direct 
loaning to small banks on their customers' paper 
as collateral. But there was no broad and depend- 
able market in which banks could always secure 
funds on their unmatured commercial paper in 
times of emergency. Furthermore, one name 
promissory notes, unlike the commercial accept- 
ances so common in Europe, are not self liquidat- 
ing paper. The notes are usually discounted at 
the payer's own bank, i. e., the bank where the 
purchaser of the goods keeps his account; not, as 
so commonly in Europe, at the payee's bank, i. e., 
the bank in which the seller of the goods keeps his 
account. They are accordingly often renewed and 
the borrowers are naturally averse to having their 
notes pass out of the hands of their friendly local 
bank, and into the hands of strangers. American 
business men in the past have strenuously objected 
to having their paper "hawked about from bank 
to bank," and the practice of rediscounting with 
another bank, when known, was looked upon as 
a sign of weakness. For these and other reasons 
American commercial paper was essentially non- 
liquid paper. It could not be realized upon until 
maturity, and often not then. It lacked the most 
fundamental requirement of a secondary reserve — 
"emergency marketability" American bankers were 
accordingly compelled to turn to bonds for their 
secondary reserves. 

180. BONDS AS SECONDARY RESERVES. 



LOANS AND INVESTMENTS 207 

— Although State banks in a number of States 
are permitted to invest in stocks, the National 
Banking Law as interpreted by the courts does 
not permit National Banks to own stocks, except 
to protect themselves from loss in the case of 
loans previously made. The authority to invest 
in bonds is enjoyed throughout the country by 
State banks, and although not expressly granted 
by the National Banking Act, has been held by the 
courts to be implied in the power to carry on busi- 
ness by discounting and negotiating promissory 
notes, drafts, bills of exchange, and other evidences 
of debt. As a matter of fact, National banks have 
invested in bonds other than United States Govern- 
ment bonds from the beginning of the National 
banking system in 1863. There has been an in- 
crease in the National banks' investment holdings 
of such securities since the inauguration of the 
Federal Reserve System. This increase, prob- 
ably of little permanent significance, because of 
the confused conditions of business during the 
early part of the war period, and because the 
release of hundreds of millions of reserve money 
through the reduction in the legal reserve require- 
ments of National banks, and the offering of lib- 
eral facilities for rediscount through the opening 
of the Federal Reserve banks, released large 
amounts of bank funds at a time when the bond 
market was particularly favorable because of the 
offering at attractive rates of big blocks of Ameri- 



208 LOANS AND INVESTMENTS 

can securities by the people of belligerent Europe 
According to the latest figures available the 
security holdings of loan and trust companies are 
slightly larger than those of National banks, while 
those of State banks are about one-third as large 
as those of National banks. 

181. SECONDARY RESERVES UNDER 
THE FEDERAL RESERVE SYSTEM.— What- 
ever may have been the utility of bonds in the past 
as secondary reserves for commercial banks, a new 
situation has been created by the Federal Reserve 
System. The twelve Federal Reserve banks provide 
liberal facilities for rediscount throughout the coun- 
try. A broad interpretation of those provisions of 
the Federal Reserve Act which describe the kinds 
of paper that can be rediscounted, has been made by 
the Federal Reserve Board. The Board has also 
made a liberal interpretation of the open market 
provisions of the act, bank acceptances and trade 
acceptances are being given preferential discount 
rates by the Federal Reserve banks, and their use 
is being slowly extended. An open discount market 
is developing. American commercial paper is losing 
its rigidity as a bank asset, and also its provincial- 
ism; it is becoming liquid and national. The Fed- 
eral Reserve authorities, leading bankers, mer- 
chants, and economists are doing much to level up 
the character of our commercial paper. Banks with 
a good grade of such paper in their portfolios can 
now, for the first time in our history, be absolutely 



LOANS AND INVESTMENTS 209 

certain of their ability to turn such paper into cash 
either by sale in the open market or by rediscount 
with a Federal Reserve bank. These privileges, to- 
gether with the provision of the Federal Reserve 
Act that after three years from the opening of the 
Federal Reserve banks, only cash in vault and on 
deposit with the Federal Reserve bank can be 
counted by a member bank as legal reserve, appear 
destined to induce commercial banks to place an 
increasing part of their demand deposits in com- 
mercial paper. 

182. BUSINESS CYCLES. — In addition to 
seasonal variations, business is affected by longer 
periods of alternating depression and activity. 
Such alternations follow one another at irregular 
intervals, and have become known as "business 
cycles." Nobody can predict exactly the length 
of any period of activity or the length of any 
period of depression. Such periods in the past 
have been of varying duration, and have been 
characterized by similar phenomena, as follows: 

(1) Beginning with a period of depression, there is a 
gradual recovery, and business reaches a stage of what may 
be called normal activity. From the normal stage business 
may develop into a condition of abnormal activity, culminat- 
ing in a crisis. The crisis itself may be accompanied by a 
panic or not, but invariably a period of depression follows 
any crisis. Banks are not mainly responsible for these 
changes, for banking operations rather reflect than create 
business conditions ; but the banking business is deeply con- 
cerned with alternations between depression and activity. 



210 LOANS AND INVESTMENTS 

When business is inactive the trend of commodity prices is 
downward, and profits are small, if there are any profits at 
all. The demand for capital is relatively small, including 
the demand for bank loans. Banks at such times commonly 
find that they could lend a good deal more than solvent 
borrowers want. At such a period there is a good deal o£ 
business house cleaning. Weak concerns are weeded out, 
and those that stand the strain are forced to put into use 
every device that will lessen the cost of production. A per- 
iod of depression, therefore, may be regarded from many 
points of view as creating the conditions necessary for more 
prosperous times. 

(2) What brings about a revival in business activity? 
It is a little difficult to say, but usually it would seem to be 
something which stimulates particular branches of business. 
It may, for example, be the active demand in foreign coun- 
tries for American agricultural products. If such a demand 
comes, and there happen to be good harvests in this country, 
obviously at least one class in the community gets a large 
and satisfactory return for its endeavors. The demand for 
other commodities from the agricultural sections of the 
country would in such circumstances unquestionably in- 
crease. Improved conditions in agriculture would have an 
effect which would be felt to a greater or lesser- extent 
throughout the whole range of industry. This demand would 
be greater in some branches than it would be in others.. 
It might be particularly great for agricultural implements. 
This increased demand for agricultural implements would in 
turn create an increased demand for iron and steel products ; 
and, again, the increased prosperity in agricultural sections 
of the country would presumably extend to the railroads and 
increase their demand for products. The increased demand 
thus spread to these other lines of business would in turn 
from them react back once more over the entire industrial 
field, and thus by a process of induction, so to speak, each 



LOANS AND INVESTMENTS 211 

kind of business would act and react upon all kinds of busi- 
ness in a favorable way. People would in such circum- 
stances begin to feel a bit more optimistic about the future. 
Wholesalers, jobbers and retailers would begin to stock up 
more largely with all kinds of commodities in which they 
deal. Financial conditions would be favorable to the advance, 
because in a period of financial depression the demand for 
capital is relatively small, including the demand for short- 
time loans. All conditions, then, are favorable to the expan- 
sion of business in case a profitable demand arises for addi- 
tional products of industry. A period of recovery has then 
been reached. 

(3) With the advent of business activity an increased 
number of people are willing to invest additional capital for 
an expected future demand. A willingness manifests itself 
to extend railroads, to enlarge factories or build new fac- 
tories, to construct additional office buildings, etc., and for 
the time being no difficulty is encountered in securing capital 
for such enterprises. This construction work necessarily 
creates an increased demand for the production of industries 
which supply material for construction purposes, notably 
the iron and steel industry. Prices now begin to advance 
and perhaps advance rather rapidly. This further increases 
business activity for the time being, for when prices advance 
profits immediately increase, and for a very natural, simple 
reason. Wages and salaries do not move up very rapidly, 
not nearly so rapidly as prices of most commodities may' 
move. Naturally, therefore, the advantages from advance 
in prices goes to those persons who own the current prod- 
ucts of industry. The persons who own the current products 
of industry are the active business men and the sharehold- 
ers in corporations. Increased profits naturally stimulate 
further enterprises, further construction and further invest- 
ments designed to supply additional commodities of all 
sorts. Nov/ the demand for capital may begin to outstrip 



212 LOANS AND INVESTMENTS 

current savings. Rates, not only for short-time loans but 
for capital which is to be invested for long periods, begin to 
advance, but the business man is perfectly ready to pay 
these higher rates, because his profits, owing to higher 
prices, are unusually large. 

(4) This is the situation of affairs during a period of 
activity which becomes a period of normal business activity. 
When prices are moving upward profits are large, and errors 
of judgment are particularly likely to be made in the invest- 
ment of additional capital. The assumption is made that 
profits will remain at their existing high level or perhaps 
reach a still higher point. Less care is exercised in such 
circumstances in making investments, and the willingness 
to pay fancy prices for the capital which is secured is 
marked. Moreover, after a time, wages do begin to advance, 
and even salaries may move up a little, though they are the 
last to be affected. The upward movement of wages may 
be more rapid after a while than the further upward move- 
ment of prices, although on the whole that does not seem 
to be the case. From the study of price statistics and wage 
statistics it does not appear that in the year or two of abnor- 
mal activity preceding a crisis wages in general have been 
moving up more rapidly than prices. The serious cause for 
trouble in the labor situation is to be found elsewhere. • The 
increased activity of business necessarily means full employ- 
ment for everybody and competition for workmen and a 
larger amount of overtime. The results are higher costs of 
production. Men are taken on rapidly, and the average 
efficiency of the men is lowered, partly because men are 
naturally not so efficient when they know they can with 
perfect ease get another equally good and perhaps better 
position, partly because of inadequate training, since busi- 
ness is so active that there is not time to train the newer 
men taken on, and partly because of overstrain. Men can 
work overtime for a short period without affecting their effi- 



LOANS AND INVESTMENTS 213 

ciency, but a good deal of overtime is bound to lessen the 
average output per hour of the workman. All of these 
elements tend to increase the labor cost of production 
toward the close of active business, and all of these are fac- 
tors quite independent of the amount of wages paid. 

(5) In a period of very active business, also, there is less 
time to devise and put into operation further arrangements 
for lessening cost. The thing which seems important is to 
get out product and get it out as rapidly as possible. Just 
because profits have been large, business men are prepared 
to take more risks. They are prepared to extend their opera- 
tions unduly on the capital which they themselves have' 
invested in their business. They trust that everything will 
come out all right, even though they allow a good many 
bills payable to accumulate ; and even though they are grant- 
ing more and more credit to their customers. Balance sheets 
show an increased amount of receivables, and an increased 
amount is borrowed on short time. When the supply of 
capital available for long-time investment becomes a scarc- 
ity, when it becomes difficult to float issues of bonds, or to 
secure money through additional preferred or common 
stock, a business which is expanding its operations is likely 
to attempt to do so on the basis of an increased amount of 
short-time credit. Now a concern which has borrowed a 
large amount on short time is in a very vulnerable position. 
If anything happens which delays collections very much, or 
if anything happens to banks which makes them desire to 
contract loans, such an overextended business gets into diffi- 
culties. Moreover, if anything happens which tends to check 
the upward movement of prices, which causes profits to de- 
cline, it will have a serious effect upon such a business, for 
after all one of the considerations taken into account in 
granting short time credit is the high earning power of the 
borrowing concern. If it is evident that the earning power 
is lessened, banks may be inclined to curtail loans. 



214 LOANS AND INVESTMENTS 

(6) All the conditions, therefore, tend to become unfav- 
orable in a period of general business activity. The situation 
becomes one in which comparatively slight disturbing 
influences may cause a collapse. It is, however, impossible 
to predict just when a collapse will come. Sometimes the 
business situation changes slowly from one of business 
activity to one of depression, without any striking or dra- 
matic circumstances. That is, however, not the rule. As a 
rule, a crisis marks the transition between business activity 
and business depression. At the end of a period of very 
active business, an exceptionally large number of concerns 
are in a position where anything which lowers their earning 
power, or which delays the payment to them for what they 
have sold, will put them into difficulties. These difficulties 
may be only temporary, if the earning power is good, but 
whether they are temporary or permanent the immediate 
effect is pretty much the same — it weakens the banks, it 
destroys confidence in the immediate future of business, and 
brings home to people generally that it is highly probable 
that over all the field of industry there are presumably many 
weak and overextended concerns. When people begin to 
feel this way about the situation, they naturally cancel all 
plans for future investment which they can by any means 
cancel. Plans for construction work of all sorts are given 
up, and the demand for the various materials which go into 
construction work falls off. Prices drop, and with the fall 
of prices profits drop, and many concerns which were based 
upon the assumption that profits would continue at the rate 
at which they were when those enterprises were started go 
to the wall. Then is seen the beginning of a period of depres- 
sion once more, which after a time will be used for another 
business house cleaning. Crises may degenerate into panics 
or they may not, and it does not depend so much upon the 
severity of the crisis as it does upon the character of the 
banking system. When a crisis comes on, people engaged in 



LOANS AND INVESTMENTS 215 

business attempt to strengthen themselves against a storm. 
They do it in two ways — by deferring payments to others 
and by seeking to get paid by others and seeking to borrow 
from banks. The demand for accommodation from the 
banks is invariably increased when a crisis comes along. 
The proceeds of such loans are commonly not used, but are 
wanted as a sort of insurance or backlog. 

(7) Under such circumstances, the contraction of loans 
by banks not only makes the general business situation for 
the moment more unsatisfactory, but it also lessens public 
confidence in the banks and leads people to withdraw money 
from the banks, thus still further strengthening the tendency 
of the banks to force contraction. In our various crises this 
course has been followed until panic conditions have been 
created, and until the banks have realized that it was impos- 
sible to insist upon further contraction because it would 
involve general ruin. The banks have then, when forced by 
panic conditions, continued loans and have also sometimes 
suspended cash payments. In other countries, and it is 
hoped in this country under the Federal Reserve System, the 
contraction of loans in crises is not insisted upon simply for 
the purpose of strengthening the banks. It is hoped that 
there will be sufficient cash and credit available so that loans 
will not be contracted at such times, but that a sufficient 
increase in loans will be made to meet the needs of the busi- 
ness community. If we get such conditions crises will not in 
the future in this country degenerate into panics. 



CHAPTER VI 



International Exchange 

183. FOREIGN EXCHANGE. — Foreign ex- 
change is the business which is concerned with the 
buying and selling in one country of rights to 
money in other countries, available either immedi- 
ately or in the future, for the purpose of settling 
debts incurred in the broad transactions of inter- 
national commerce. The business seems commonly 
to be regarded as a very mysterious subject, one 
beset with innumerable complications. The gen- 
eral principles of the subject are, however, by no 
means abstruse. The conduct of a foreign ex- 
change department requires special training and 
a certain natural ability; but any intelligent per- 
son can readily obtain an understanding of the 
subject, and such an understanding is of much 
value to those engaged in other branches of 
banking. 

184. DOMESTIC EXCHANGE.— Much for- 
eign exchange business is closely akin to certain 
kinds of domestic business carried on by all banks, 
such as making payments and collections between 
different parts of the country. In this particular 
domestic exchanges are closely analogous to for- 
eign exchanges. Domestic exchange rates rise and 
fall within limits which are set by the plentifulness 
or scarcity of drawable funds in financial centers 

216 



LOANS AND INVESTMENTS 217 

or by the cost of shipping currency between any 
two places. The quotations are usually expressed 
in a premium or discount on a purchase or sale of 
$1,000. If it costs, for example, 50 cents to ship 
$1,000 between two places, the rate of exchange 
may be up to 50 cents above or below par, depend- 
ing upon the effect of supply and demand upon 
the funds utilized. 

185. DEMAND RATES OF EXCHANGE.— 
Foreign exchange demand rates fluctuate in es- 
sentially the same way. They move above and 
below par to the gold export or gold import point, 
and these export and import points are determined 
by the cost of shipping, not currency, but gold. 
Quotations are, however, expressed in a different 
manner, because of the differences in the monetary 
units of different countries. It would be incon- 
venient to express foreign exchange rates in the 
terms used for domestic exchange, although it 
would be possible. 

186. MINT PAR OF EXCHANGE. — The 
basis of exchange between two systems of coinage 
is known as the mint par of exchange, and is de- 
scribed as the rate at which the standard coin of 
one country is convertible into the standard coin 
of another in accordance with mint laws. This 
basis of exchange can only be effective between 
countries having the same standard of value. As 
an example, the English sovereign is by law made 
to weigh 123.27447 grains troy or 7.98805 grammes 



218 LOANS AND INVESTMENTS 

of gold eleven-twelfths fine. The United States 
ten dollar gold piece, the golden eagle, is by law 
made to v/eigh 258 grains of gold, nine-tenths fine. 
To find the mint par between the two coins, the 
following method is used : 

Question — Flow many dollars equal one pound? 

If the weight of one pound equals 123.274 grains 
standard gold — 

If standard gold of 12 grains equals 11 grains 
of fine gold — 

If fine gold of 232.2 grains equals 10 dollars — 
1 X 123.274 X 11 X 10 

= $4.8665 

1 X 12 X 232. 2 

Mint par is — One pound equals 4.8665 dollars. 

187. STERLING EXCHANGE. — If it costs, 
for example, in normal times, $2.50 to ship $1,000 
in gold to England, then $2.50 sets the limit to 
the possible fluctuation in sight exchange. The 
par of exchange between the United States and 
England is $4.8665 and the exchange rates fluctu- 
ate above and below this figure by the cost of ship- 
ping gold to England. Such cost is usually at 5 
per mille, or .024 cents. This added to the mint 
par of exchange is dollars 4.89, which we may 
assume to be the limit beyond which the American 
debtor will not go in buying exchange on London 
for gold will then be shipped to settle debts. This 
limit is known as a gold or specie point. 

188. FRENCH EXCHANGE.— In the case of 



LOANS AND INVESTMENTS 219 

France the quotation is expressed in a different 
manner. Instead of being expressed in United 
States money it is expressed in francs — in the 
number of francs which the gold in the dollar will 
make. The gold in a dollar will make five francs 
eighteen and one-eighth centimes (francs 5AS%). 
Exchange on Paris therefore fluctuates above and 
below this point by the cost of shipping gold to 
Paris. 

189. GERMAN EXCHANGE.— Exchange on 
Berlin, like that on London, is expressed in United 
States money, but instead of using the mark, four 
marks are made the basis of the quotation. The 
gold in four marks coined into dollars makes ninety- 
five and three-sixteenths cents (cents 95 3/16). 
Consequently German exchange may rise above 
and fall below this point by the amount that it 
costs to send gold to Berlin. Changes in Paris and 
Berlin rates are usually quoted in fractions, 1/8, 
1/16, and 1/32, while sterling exchange is quoted 
to four points of decimals. 

190. SIGNIFICANCE OF CHANGES IN 
EXCHANGE QUOTATIONS.— When exchange 
is expressed in United States currency, a rising 
quotation indicates an approach towards the export 
point. It also indicates a demand for remittances 
which is in excess of the supply. When, however, 
quotations are expressed in the currency of a for- 
eign country, the opposite is true. A fall in the 
quotations then indicates an approach to the export 



220 LOANS AND INVESTMENTS 

point. For example, a payment of one thousand 
pounds is to be made in London. If exchange is 
near the export point more will be paid than if it 
is near the import point, for at the export point 
the gold value of the sovereign plus the cost of 
shipping will be paid. If the rate were $4.88, more 
would be paid to send one thousand pounds to 
London than if the rate were $4.86. But suppose 
it is desired to pay one thousand francs in Paris. 
Clearly more will be paid if only 5 francs 16 cen- 
times are obtainable for a dollar than if 5 francs 
18 centimes for a dollar were obtainable. 

191. EXPORT AND IMPORT POINTS.— 
The expenses incurred in shipping gold determine 
the export and import points, or gold or specie 
points as they are known. The obvious expenses 
are freight, insurance, commission and the cost 
of packing the gold. All these elements of expense 
are somewhat variable. Freight charges may not 
be uniform, and it makes a difference as to the 
kind of gold available for shipment. The most 
inexpensive form for the purpose is gold in bars. 
Bars can be packed more handily, are of full weight, 
and there is less loss from abrasion than in the 
case of shipments of coin. Gold bars are secured 
from the United States Treasury at a constant 
charge of 4 cents per $100. In the past it has not 
always been possible to get an adequate supply of 
bars, but in the future this difficulty will probably 
not present itself, because the Government has 



LOANS AND INVESTMENTS 221 

been empowered to hold gold in the form of bars 
against gold certificates. Formerly all the gold 
thus held was coined. The export point will at 
times in the future be a little lower than in the 
past, because of this possibility of securing gold 
bars. 

192. VARIABLE PRICES OF GOLD.— The 
great European central banks have a sliding scale 
of rates for gold, buying bars and foreign coin at 
coinage value as a maximum price and at that 
price less the loss of interest during the period 
required for coinage as a minimum price. In sell- 
ing gold they impose rates which offset in varying 
degree the advantage of shipping bars or foreign 
coin rather than more or less worn domestic coin. 
By these means the importation of gold is at times 
stimulated, or its exportation obstructed, but the 
influence is slight and temporary. In the long run 
they have no appreciable influence upon the dis- 
tribution of the precious metal throughout the 
world. 

193. TIME FACTOR IN GOLD SHIP- 
MENTS. — A very important element of expense 
in gold shipments is time. If a fast express steamer 
is sailing the import point is nearer par than during 
a week when only the slower boats are available. 
This is a factor, however, only influencing imports. 
When $1,000,000 of gold is exported sight exchange 
can at once be sold to an equivalent amount. The 
exporter has his money at once. Suppose, how- 



222 LOANS AND INVESTMENTS 

ever, it is a case of imported gold. The importer 
loses the interest the money would have earned in 
London while the gold is in transit, consequently 
the gold import point is somewhat further away 
from par than the gold export point. If we assume, 
for example, that at a given moment the gold ex- 
port point to London is about V/ 2 cents above par, 
then we would probably find that the gold import 
point was something like 2 cents below par, the dif- 
ference being increased or diminished as foreign 
interest rates rose or fell. It should also be noted 
that foreign central banks frequently allow immedi- 
ate credit for gold while in transit. This, of course, 
brings the export point still .nearer the par of 
exchange. There has been a slow but steady re- 
duction in the possible range of demand exchange 
fluctuation. Twenty or thirty years ago the export 
point to London was above $4.89. It is now 
normally in the neighbourhood of $4.88. The im- 
port point was then in the vicinity of $4.83. It is 
now normally above $4.84. But from what has been 
said it will be seen that the exact point at which it 
is possible to expert or import gold at a profit is 
subject to much variation even within short periods 
of time. 

194. CABLE TRANSFERS.— The cable trans- 
fer rate is always above the demand rate. It gives 
the purchaser the amount of his purchase immedi- 
ately, whereas in the case of demand exchange the 
proceeds will not be placed to his credit until the 



LOANS AND INVESTMENTS 223 

steamer arrives on the other side six to ten days 
later. The seller of cable transfers loses interest 
on the amount of his sales at once, since his bal- 
ances in the foreign banks, which uniformly draw 
interest are at once reduced. The interest rate on 
these balances is not, however, constant. There 
is a varying spread between the cable transfer rate 
and the demand rate. If, for instance, a foreign 
exchange dealer is getting iy 2 % upon his balance 
in London at one time, and at another time is get- 
ting 2%, he will naturally charge more for a cable 
transfer in the second case than he would in the 
first. There are also special causes for fluctua- 
ton in cable transfers. It sometimes happens that 
many persons defer making necessary remittances 
in expectation that rates will go down at the last 
moment. They must meet their engagements on 
the other side, and the demand at such times for 
cable transfers may cause the rate to move ab- 
normally far from the demand rate. 

195. RATES ON TIME BILLS.— A glance at a 
newspaper will show that in addition to cable trans- 
fer and demand rates there are a variety of other 
rates generally quoted— -bankers' bills and various 
kinds of commercial bills drawn for varying periods 
of time. Rates for these bills are always lower 
than demand rates. If it was found that the de- 
mand rate on London was $4.86 it might also be 
found that the rate on bankers' 60-day bills was 
$4.83, and it might be found that the rate on a 



224 LOANS AND INVESTMENTS 

certain class of commercial bills was $4.82^ and 
on another kind $4.82. The quotations on time 
bills are less than those for demand exchange by 
the amount of the varying costs of discounting 
them in the foreign country on which they are 
drawn, and by the stable costs of commissions and 
stamp taxes. If the rate of discount on a 60-day 
banker's bill is 3% in London, then the quotation 
for a bill of similar kind in New York will be the 
sight rate of exchange less the discount and other 
charges on the bill in London. Should the discount 
rate in London advance on that particular kind of 
bill, then the quotation will move somewhat farther 
away from the sight rate. The reason for the 
different prices or quotations for the various kinds 
of time bills is that there is a scale of discount 
rates in the London market dependent upon the 
character of the bill. The lowest rate prevails on 
bills drawn for acceptance on a London bank or 
acceptance house. There are usually various other 
rates increasing up to the "bank rate," which is 
the rate of discount of the Bank of England. 

196. CLASSIFICATION OF TIME BILLS. 
— Bills without documents, known as clean bills, 
are usually marketed by drawers of well known 
and established credit. Most foreign trade gives 
rise to documentary bills of exchange. The seller 
draws a bill of exchange upon the purchaser, or 
upon the bank of the purchaser, attaching to the 
bill various documents, the most important being 



LOANS AND INVESTMENTS 225 

the bill of lading, without which it is impossible to 
secure possession of the goods. Documentary bills 
are of two kinds, documentary for payment and 
documentary acceptance bills. In documentary 
payment bills the purchaser of the goods can not 
get possession of them until he has paid the bill 
of exchange. These payment bills, again, may be 
classified as those drawn against sales of perish- 
able goods and such other goods as the purchaser 
is fairly certain to want immediately upon arrival, 
and those drawn in connection with goods which 
the purchaser may not want until the bill matures. 
If the purchaser desires the goods immediately 
and makes payment, he is allowed a rebate, which, 
in the case of English bills, is 1% below the cur- 
rent Bank of England rate. Therefore the maxi- 
mum price of such bills is the sight rate of exchange, 
less the rebate and the ordinary commission and 
stamp tax. If the goods are of a kind which are 
not likely to be wanted by the purchaser until 
maturity of the bill of exchange, then the dealer^ 
purchasing the bill may be obliged to hold it until 
maturity. If he does not care to finance the trans- 
action during the life of the bill it cannot be dis- 
counted, because the purchaser of the goods may 
at any time exercise his right of taking up the 
bill. The exchange dealer may, however, use such 
bills as collateral, drawing his own bill upon his 
foreign correspondent. 
197. DOCUMENTARY ACCEPTANCE 



226 LOANS AND INVESTMENTS 

BILLS.— -Documentary acceptance bills are of two 
kinds — those which are drawn for acceptance on a 
merchant, and those which are similarly drawn on 
a bank or acceptance house. Naturally the latter 
command the better rate, because the acceptors 
are universally known. Documentary acceptance 
bills on merchants are regularly discounted at a 
slightly higher rate in London, and consequently 
the price of such a bill in this country will be 
slightly lower than documentary bills on London. 
For this reason, to an increasing extent the bank 
acceptance is displacing the commercial bill in 
foreign trade throughout the world. The importer, 
for example, secures an acceptance credit for some 
definite amount with a well known bank in his own 
or some other country. He then instructs his agent, 
or those from whom he purchases goods, to draw 
bills accompanied by shipping documents upon the 
accepting bank. Similarly the exporter may draw 
bills on banks in his own or in some other country 
with which his customers have established ac- 
ceptance credits. 

198. ARBITRAGE.— Arbitrage is the utiliza- 
tion of all the principal financial centers of the 
world for the purpose of purchasing in the cheapest 
markets exchange to cover the obligations of 
definite transactions. A New York banker sells 
a 60-day bill on London. To meet this bill at 
maturity he may cause Dutch, French or Russian 
bills on London to be remitted to that city for his 



LOANS AND INVESTMENTS 227 

account, always using in largest volume those bills 
which are procured most cheaply. Such transac- 
tions maintain the equilibrium of the world's prin- 
cipal exchanges. The dealer in arbitrage is very 
similar to the stock broker who specializes in cer- 
tain stocks and uses all the bourses of the world 
to make his deliveries as cheaply as possible to the 
advantage of his profit account. Arbitrage re- 
quires specialization and is a distinctive field. 

199. FINANCE BILLS.— The finance bill is 
an instrument of foreign exchange connected in 
largest measure with speculative transactions. It 
is a bill drawn by a banker on a correspondent 
banker. A stock exchange firm is desirous of mak- 
ing a loan to complete a speculative transaction in 
which it is engaged. Under the ordinary method 
of procedure it places with its banker acceptable 
collateral, with a margin of 20%, and gives a note 
for the amount desired. The banker negotiating 
the loan, in order to make the amount of the loan 
again available for his use, draws a 60 or 90-day 
bill upon his foreign correspondent, usually one 
in London, which he sells in the New York market. 
When this bill arrives in London it is accepted by 
the banker upon whom it is drawn and funds are 
provided at maturity for its cancellation. Often- 
times another bill of similar kind is drawn to pro- 
vide for the payment of the one maturing. A free 
use of this instrument would cause American ex- 
change on London to cheapen. 



228 LOANS AND INVESTMENTS 

200. REVOLVING CREDIT.— Most credits 
opened for the purpose of enabling exporters to 
obtain payment for goods when ready for shipment 
can be made into revolving credits. There are 
three forms of revolving credit: (a) The exporter 
is accorded the privilege of drawing drafts in an 
amount outstanding at any one time of $10,000, 
for example, which drafts are drawn as the goods 
are ready for shipment. When the full amount of 
the established credit is exhausted no drafts can 
then be drawn until any or all of the outstanding 
drafts are paid, at which time the amount of the 
paid drafts again becomes available to be drawn 
against, provided, always, that the amount of the 
credit as originally established is not exceeded; 
(b) A credit, for example, is established for $10,000. 
It is to be drawn against in one draft. When the 
draft so drawn has been paid the full amount of the 
credit is again available; (c) A credit, for ex- 
ample, is established for $10,000. It is to be drawn 
against in one amount. When such a draft has 
been drawn, the full amount is again available to 
be drawn against. This is practically a credit for 
an unlimited amount. 

201. TRAVELERS' LETTERS OF CREDIT. 
— Travelers' letters of credit are widely used and 
very generally known. They are at once a letter 
of introduction, and also a request from one banker 
to other bankers in business relationship with him 
to accord courtesies to and to pay to the holders 



LOANS AND INVESTMENTS 229 

thereof a sum of money in amount not to exceed 
the amount provided for in the letter. The issuing 
banker obligates to hold himself liable for drafts 
drawn under the terms of the letter, and for this 
he usually charges a commission on the amount 
of the letter of credit. If the letter is to be used 
throughout the world an authenticated book con- 
taining a list of correspondents who will cash 
drafts thereunder is given the holder of the letter 
of credit. A letter so issued is termed a circular 
letter of credit. When a letter is available in cer- 
tain centers only, the issuance of such letter is 
especially advised to the banker upon whom it is 
made available and signatures of the holder are 
forwarded at the same time. 

202. EUROPEAN FINANCING OF AMERI- 
CAN FOREIGN TRADE. — The United States, 
like other rapidly developing countries, has not in 
the past financed any appreciable amount of its 
foreign trade, either of exports or of imports. De- 
mands for capital within the country have been so 
great that rates for loans have regularly been above 
those in European money centres, and especially in 
London. London, and to the same extent other 
European money markets, have, therefore, financed 
not only the trade between Europe and the rest of 
the world, but also trade between non-European 
countries. 

203. FINANCING OF IMPORTS. — Let us 
take, for example, the case of an importation of 



230 LOANS AND INVESTMENTS 

wool to the United States from Australia. The 
most common way of arranging payment has been 
through the commercial letter of credit on a Lon- 
don bank. Let us suppose that a Boston wool 
house is about to purchase a cargo of wool. It will 
secure through some foreign exchange banker in 
this country an acceptance credit with some Lon- 
don bank. Under the terms of this credit, the 
agent in Australia of the Boston wool house will 
be empowered to draw documentary acceptance 
bills up to a certain amount on the London bank. 
Upon the purchase of the wool a bill on the Lon- 
don bank is drawn, and with shipping documents 
attached it is sold to some Australian bank. Thus 
the funds are provided with which to pay for the 
wool. The Australian bank sends the bill with 
documents to its London correspondent, and at the 
same time ordinarily will sell an equivalent amount 
of sight exchange against the credit which it will 
secure in London through the discount of the docu- 
mentary bill. No one in Australia has any further 
connection with this transaction. The correspond- 
ent of the Australian bank in London takes the bill 
with its documents to the London bank on which 
it is drawn for acceptance. Having been accepted 
by the London bank, which takes the shipping 
documents, the bill is discounted in the open market 
by the London agent of the Australian bank. This 
provides funds to meet the sight exchange which 
the Australian bank had sold. The London bank 



LOANS AND INVESTMENTS 231 

which accepted the bill then sends the documents 
to this country to the foreign exchange banker 
through whom the arrangement was made or per- 
haps to a shipping broker. The wool house can not 
get possession of the wool until it can get the bill, 
and the exchange banker need not give up this 
document until he is provided with funds sufficient 
to purchase the sight exchange on London neces- 
sary to meet the payment of the bill accepted by the 
London bank. Thus everyone is secured at each 
stage in the transaction, in so far as the bill itself 
may be regarded as security. 

204. FINANCING OF EXPORTS. — Here 
let us take the case of a shipment of goods from 
United States to South America. The financing 
is handled in a number of different ways, but 
one of them will serve for illustrative purposes. 
A commission house exporting goods to South 
America will commonly be paid in 90-day drafts 
on some London bank, drawn by the South Ameri- 
can purchaser of the goods. If the commission 
house waits until these bills mature, it will be a 
long time out of its money — the time that the 
goods are in transit to South America, the time 
that is required in sending the bill of exchange to 
London, and 90 days thereafter. Something like 
six months will elapse before the maturity of the 
bill. But the commission house in New York wants 
its money at once. It may itself, therefore, draw a 
90-day bill upon a London bank and get the cash 



232 LOANS AND INVESTMENTS 

by selling this bill in the New York market. This 
90-day bill will be sent to London and discounted 
in the London market. Thus it will be seen that 
London really finances the shipment of goods from 
New York to South America. When the 90-day 
bill falls due the New York house must provide 
payment, since the South American bill is not yet 
due. This it can manage by discounting the South 
American bill in the London market. Finally, 
when this bill matures, means of payment will have 
been provided by the South American purchaser 
of the goods. Thus during the period of six months 
London has financed the transaction; first, by dis- 
counting the bill of the New York commission 
house, and then by discounting the bill drawn by 
the South American purchaser. 

205. FOREIGN EXCHANGE DEPART- 
MENTS. — A considerable number of banks 
throughout the country have established foreign 
exchange departments in recent years. They have 
entered into the necessary arrangements with 
foreign banks, establishing balances with them, and 
are thus able to provide their customers directly 
with cable transfers, sight drafts, and also letters 
of credit, both travellers' and commercial. A for- 
eign exchange department of this kind does not 
require any considerable amount of capital. It can 
be conducted on a small margin. Indeed, so far as 
the ordinary bank is concerned, it is quite feasible 
for the foreign exchange department to clean up 



LOANS AND INVESTMENTS 233 

every day. It will purchase time bills of exchange 
drawn against merchandise shipments, which it can 
secure either from New York or direct at the rate 
at which these bills on receipt will be discounted in 
London or elsewhere. It therefore incurs no risk 
from fluctuations in foreign rates of discount — 
fluctuations which the American banker would 
hardly be in position to forecast. Having pur- 
chased time bills at a rate which is less than the 
demand rate of exchange by the amount of the 
discount on arrival, stamp tax and commission, 
the bills may be at once sent on for discount, and) 
at the same time the foreign exchange department 
may sell an equivalent amount of demand ex- 
change. Of course, if the foreign exchange man- 
ager cares to take a risk, he need not sell demand 
exchange equivalent to his purchases of time bills; 
but if he has not very much capital to work with, 
and wishes to avoid practically all risk from fluctua- 
tions in exchange rates, it is ordinarily possible 
to do so. 

206. HOW THE DEMAND RATE OF EX- 
CHANGE IS DETERMINED.— The many banks 
scattered all over the country which have foreign 
exchange departments do not directly have any- 
thing to do with the determination of the sight 
rate of exchange. That rate is determined by the 
operations of a comparatively small number of 
dealers in exchange in New York City. Some of 
them are private banking firms, and others are the 



234 LOANS AND INVESTMENTS 

managers of foreign exchange departments of 
banks and trust companies. These institutions and 
firms necessarily incur a certain amount of risk 
in connection with foreign exchange dealings. 
They buy and sell a more or less indefinitely large 
amount of sight exchange. If it is believed by one 
of them, taking into consideration all of the various 
inferences, that rates are going down, he will be 
likely to offer a good sized block of sight exchange, 
and if another takes the opposite view he will be 
prepared to buy. Dealings between the large for- 
eign exchange houses are reflected in constant vari- 
ations in the demand rate of exchange. Sometimes 
the exchange market is quiet, but at times it is in 
a feverish condition. Those who are engaged in 
the foreign exchange business in New York must 
take#account of every influence which may increase 
or diminish the amount of foreign exchange ma- 
terial. What may be called the foreign exchange 
material consists in the first place of all sorts of 
time bills drawn against or resulting from exports 
and imports of merchandise. All of the com- 
mercial bills drawn against cotton shipments, 
grain, petroleum shipments, etc., build up balances 
on the other side against which exchange may be 
sold. Interest payments, shipping charges, tourist 
expenses, dealings in securities, issues of American 
securities marketed abroad or resold to this 
country, all provide foreign exchange material. 
207. INTERNATIONAL BORROWING.— 



LOANS AND INVESTMENTS 235 

In addition to all these exchange creating factors, 
there are temporary loans made by one foreign 
market in another foreign market. These may be 
made in a variety of different ways. The foreign 
exchange house in New York enjoying good credit 
may for example draw bills upon a London cor- 
respondent payable in three months. These bills, 
on acceptance by the London correspondent, may 
be readily discounted, thus giving the American 
exchange house a balance to the amount of the 
bills, and enabling it to sell an equivalent amount 
of sight exchange in New York. This is what 
ordinarily happens in the case of foreign borrow- 
ing. No actual money commonly moves between 
the two markets. Similarly, borrowing may be 
arranged by an exchange dealer for one of his 
clients who may deposit collateral as security. 
Sometimes the initiative may be taken by a for- 
eign banker who desires to lend in this market. 
Profit on these foreign loans is largely determined 
by the course of the sight exchange rate. Suppose, 
for example, that the sight rate of exchange is $4.86, 
and that a long bill is drawn and sold at $4.82, a 
difference reflecting the discount rate on London. 
When the long bill matures, the borrower must 
purchase sight exchange with which to take it up. 
If the sight exchange rate is then still at $4.86 he 
will have paid only four cents on each pound for 
the use of the money during the period. But in the 
event that the sight rate has gone up to $4.87 his 



236 LOANS AND INVESTMENTS 

loan is more costly, as he will be paying five cents 
for each pound. These foreign short time loans do 
not ordinarily occasion movements of money into 
the borrowing country, but they frequently check 
gold exports. They are seldom made except when 
the rate of exchange is high — toward the export 
point. Let us suppose that the rate in New York 
for three months' collateral loans is 5%, and that 
the discount rate in London is 3%. It may then be 
advantageous to borrow in London if the sight rate 
is at least as high as $4.87. It can not go much 
above $4.88, and it may be at a much lower point 
three months hence, when it becomes necessary to 
purchase demand exchange. If the rate does go 
down, it reduces the cost of the loan to the bor- 
rower. If, however, he should enter upon this 
transaction when the sight exchange rate was $4.85, 
he would incur the risk of a possible advance to 
$4.88, making the loan an extremely costly affair. 
208. LOANS BY FOREIGN BANKS.— The 
foreign lender may be willing to take the risk of 
fluctuations in the sight exchange rate. If so he 
lends in currency. Suppose, for example, that the 
quotation on banker's time bills is $4.83, and that 
some one in New York wishes to borrow $500,000. 
The bill is drawn for say £100,000 on London by 
the New York agent of the London bank, acting 
on instructions. The bill is sold for $4.83, and the 
proceeds are turned over to the borrower in New 
York; that is, he gets $483,000. When the bill ma- 



LOANS AND INVESTMENTS 237 

tures, the borrower must return $483,000, plus what- 
ever rate of interest has been agreed upon, let us 
say 5%. The borrower is not affected by fluctua- 
tions in sight exchange. But now the foreign lender 
may desire to get back his money in London. He 
instructs his correspondent to buy sight exchange 
on London. If the demand rate has gone down, 
then the London bank gains from having assumed 
the risk. If the sight rate is down to $4.85, for in- 
stance, it can buy sight drafts on London for 
£100,000 for $485,000. It gets the benefit of the 
higher return. If the sight rate were $4.87, it 
would be obliged to pay $487,000 in order to get its 
money back in London. When the foreign banker 
is inclined to think that the rate on sight exchange 
is going down, he will be willing to lend in currency 
in this market; if his opinion is the other way, then 
the risk will have to be assumed by the borrower. 
He will receive the proceeds of the bill just as in 
the other case, but at the maturity of the bill he, 
must provide the means for its liquidation in Lon- 
don, paying for the exchange at current rates. 

209. RELATION OF INTEREST RATES 
TO EXCHANGE RATES.— It will thus be seen 
that interest rates have an important influence upon 
fluctuations in exchange rates over short periods of 
time. Whenever there is a large balance of pay- 
ments against a country, temporary borrowing can 
not prevent exchange rates in the long run from 
moving to the export point. But within limits it is 



238 LOANS AND INVESTMENTS 

possible to postpone gold movements if interest 
rates go to a much higher level than those prevail- 
ing in the foreign countries to which heavy pay- 
ments are due. In such circumstances, so long as 
the credit of the debtor market remains good in 
foreign countries, very considerable temporary 
loans may be made, thus providing sight exchange. 
But if a large number of three month bills are 
drawn now, at the end of the three months' period 
it is necessary to make payments or secure renewals 
and renewals can not be continued indefinitely. 

210. UTILITY OF BANKERS' TIME 
BILLS. — Within moderate limits, borrowing by 
means of bankers' time bills serves a useful purpose, 
tending to steady the sight rate of exchange. In 
the absence of these bills a comparatively slight 
excess in the demand for or supply of exchange 
would cause rates to move violently between the 
export and the import points. When drawn for the 
purpose of steadying the exchanges they are some- 
times spoken of as anticipatory bills. Bankers' 
bills, for example, are regularly drawn by New 
York in the early summer months, because it is 
known that in the autumn a great quantity of com- 
mercial exchange will come into the market in con- 
nection with exports of cotton and grain. Antici- 
patory bills are in no sense different from other 
bankers' bills. It is simply that within limits and 
at certain times they really are anticipatory. The 
term finance bills is sometimes used in a derogatory 



LOANS AND INVESTMENTS 239 

sense, as if commercial bills were the only perfectly 
reputable variety of bills of exchange. Bankers' 
bills are, however, essential for the smooth working 
of the exchanges. Both commercial bills and bank- 
ers' are serviceable in various transactions. 

211. BORROWING AND LENDING EX- 
CHANGE MARKETS.— From the foregoing dis- 
cussion it may have been inferred that there are 
two more or less distinct groups of foreign ex- 
change markets — borrowing markets and lending 
markets. The borrowing markets are numerous, 
while the lending markets are few, with a strong 
tendency for a single market to acquire nearly the 
entire business. In many ways it is advantageous 
to have one city in the world which serves as a 
centre for payments between all parts of the world. 
London became the central money market of the 
world, reaping all the advantages of that position, 
because it has been able to absorb whatever amount 
of foreign bills might be sent thither for discount. 
This is an essential condition for the normal work- 
ing of the exchanges under a system of settlements 
largely concentrated in a single market. The mar- 
ket on which bills of exchange are drawn, as we 
have seen, must be prepared to discount them. In 
order to avoid the risk of loss from fluctuations in 
exchange, bankers purchasing time bills drawn on 
another country, must be able to discount them 
at once in that market, so that they may be able 
to sell demand exchange against the proceeds. 



240 LOANS AND INVESTMENTS 

212. ARRIVAL RATES.— Exchange bankers 
in New York and in all other exchange markets 
each day, and oftener if rates change, receive spot 
and forward delivery quotations from London cor- 
respondents. Spot quotations, as the name implies, 
are discount rates on bills already in London. For- 
ward delivery quotations are the rates at which 
London bankers and discount houses agree to take 
bills arriving in the next mail from the market to 
which they are quoted. These arrival rates enable 
exchange bankers in New York and elsewhere to 
purchase time bills without running any risk from 
changes in London discount rates while the bills 
are in transit. When downward tendencies in Lon- 
don discount rates seem probable, the banker may 
not take advantage of the arrival rate; just as in 
the belief that exchange rates are to advance he may 
decide to hold the bills to maturity. In fact the ad- 
vantages and uses of forward delivery quotations 
are in every way analagous to those arising from 
discounting bills which have already been delivered. 
In one case the arrangement eliminates risk during 
the transit period, in the other during the entire life 
of the bill after it reaches the country on which it 
is drawn. 

213. POSITION OF LONDON.— It is evident 
therefore that if time bills of exchange are to be 
handled with a minimum of risk it must always be 
possible to discount them in the country on which 
they are drawn. This has always been possible in 



LOANS AND INVESTMENTS 241 

London, and at rates which have averaged some- 
what below those prevailing in other money mar- 
kets. For this reason and because it facilitates set- 
tlements and makes possible a broad exchange mar- 
ket on all countries, foreign bills of exchange 
throughout the world for many years preceding 
the European War had been principally drawn on 
London. Persistent efforts to give bills on other 
money centres, notably Berlin, the standing of the 
sterling bill, have not succeeded. In addition to its 
readiness to absorb the indefinitely large volume of 
foreign bills, London also has exercised most effec- 
tively another essential function — that of accepting 
bills for banks and traders in all parts of the world. 
Until recently the acceptance business in London 
was conducted almost entirely by private banking 
firms known as accepting houses ; but of late years 
the joint stock banks have entered this field. The 
value of the London acceptance was due not so 
much to the financial strength of the acceptors as 
to the knowledge of the financial standing of banks 
and traders throughout the world which they had 
acquired, and the skill and restraint which they had 
manifested in the conduct of this important branch 
of the banking business. 

214. EUROPEAN WAR AND THE EX- 
CHANGES. — These various interdependent for- 
eign exchange functions have been developed dur- 
ing a long period in which peace had become the 
normal condition of the world. It is, therefore, no 



242 LOANS AND INVESTMENTS 

more than was to have been expected that with the 
approach of the European war the entire mechan- 
ism of foreign exchanges should be so seriously 
dislocated as to come almost to a standstill. On] 
Saturday, July 25th, 1914, foreign exchange opera- 
tions were still being conducted in normal fashion 
throughout the world. Demand exchange in New 
York was quoted at $4.8830. Gold exports in con- 
siderable quantities seemed imminent, but nothing 
more serious seems to have been expected. Over 
Sunday the outbreak of a general European War, 
which had been commonly regarded as a vague pos- 
sibility, became alarmingly probable. On Monday 
demand exchange opened at $4.92 and the foreign 
exchange market was completely disorganized. 
This condition was in no way peculiar to New York. 
Foreign exchange dealings between all of the 
money markets of the world were in a similar ab- 
normal state. In no other business was the effect 
of the approach of the war felt so immediately, 
generally and severely. The complicated and deli- 
cately balanced mechanism of foreign exchanges, 
developed during long years of peaceful intercourse, 
collapsed like a house of cards. 

215. THE WAR AND THE LONDON AC- 
CEPTANCE.— Two operations essential for the 
working of the foreign exchanges had been instantly 
interrupted, and, indeed, practically discontinued — 
the business of accepting and that of discounting 
foreign bills of exchange in London. When Lon- 



LOANS AND INVESTMENTS 243 

don ceased to perform these two functions, the 
mechanism of the foreign exchanges throughout 
the world inevitably and at once became completely 
disorganized. Acceptors on London were under 
heavy obligations on bills of exchange drawn by 
banks and merchants throughout the world, who 
in turn were under obligation to remit funds to 
them before the maturity of the bills. Among these 
bills accepted in the ordinary course of business 
were a large number, amounting in the aggregate 
doubtless to many millions of pounds, for banks and 
merchants in the countries which were rapidly drift- 
ing toward war. Remittances could not be expected 
from parties in hostile countries until after the res- 
toration of peace. It was also certain that remit- 
tances would be delayed in many instances in the 
case of bills accepted for clients in allied and also 
in neutral countries, owing to the disturbances oc- 
casioned by the outbreak of the war. In these cir- 
cumstances acceptors in London were in no position 
to make new acceptances, and the value of the ac- 
ceptance itself was impaired. It should further be 
noted that exchange banks in New York and in alii 
other markets were under heavy contingent liabili- 
ties on account of endorsements of bills drawn on 
London acceptors. In the event of the failure of 
London accepting houses, these bankers would have 
to supply funds to take up the bills, and in the dis- 
turbed conditions prevailing might incur serious 
loss through the failure of drawers, to whom of 



244 LOANS AND INVESTMENTS 

course they would have recourse. Uncertainty re- 
garding the value of the London acceptance com- 
pletely transformed the character of the business 
of buying commercial bills of exchange. A busi- 
ness which normally is highly secure and even rou- 
tine in character was in a moment changed to one 
surrounded with uncertainties of a most unfamiliar 
and incalculable nature. At the same time shipping 
hazards, and uncertainty as to market conditions 
in foreign countries, were taking away much of the 
value of the security which the bill of lading ordi- 
narily gives in the case of bills drawn against ex- 
ports. Both exporters and those who might pur- 
chase their bills would therefore be embarking upon 
venturesome transactions, utterly lacking the 
highly developed safeguards which normally pro- 
tect international dealings, both in commodities 
and in bills of exchange. 

216. THE WAR AND THE LONDON DIS- 
COUNT MARKET.— The consequences of the un- 
certain position in which London acceptors were 
placed by the approach of the war do not seem to 
have been at once fully realized even in foreign ex- 
change circles. They were perhaps overshadowed 
by the presence of another disorganizing influence, 
the full force of which was immediate and obvious. 
From Monday, July 27, to the middle of August, 
the business of discounting foreign bills in London 
was almost entirely suspended. With the approach 
of the war it might well have been presumed that 



LOANS AND INVESTMENTS 245 

London would decline to quote forward delivery 
rates before the discounting of bills already in Lon- 
don was discontinued. As it happened, both spot 
and forward delivery quotations were discontinued 
at the same time, on Monday, July 27, striking evi- 
dence of the great change for the worse which af- 
fairs had taken over Sunday. 

217. THE WAR AND THE NEW YORK 
EXCHANGE MARKET.— This discontinuance of 
discount quotations by London was the most im- 
portant single factor in the exchange market in 
New York and elsewhere throughout the world on 
Monday, July 27. It involved a complete transfor- 
mation, not only of the business of buying commer- 
cial bills, but also of conditions in the demand ex- 
change market as well. On Saturday the exchange 
banker purchasing commercial bills could arrange 
discount terms at once in London and sell demand 
exchange against the proceeds. On Monday the 
purchase of such bills involved the investment of 
capital until the date of maturity in a far from satis- 
factory security, owing to the position of London 
acceptors. On Saturday every commercial bill of- 
fered in the market provided the means for an im- 
mediate sale of demand exchange. On Monday the 
immediate supply of demand exchange could no 
longer be enlarged to the slightest extent by this 
means. The principal source of an immediate sup- 
ply of a demand exchange was entirely cut off. 
Demand exchange could still be sold against for- 



246 LOANS AND INVESTMENTS 

eign balances, but these were not large. The ex- 
portation of gold was a further source of supply of 
demand exchange, but could not go on indefinitely 
without endangering the foundation of the domes- 
tic credit structure. In these circumstances, al- 
though exchange transactions were not entirely 
suspended, there was a complete cessation of cer- 
tain exchange operations, in the absence of which 
there can be no broad exchange market. Each 
dealer made every effort to provide the exchange 
urgently needed by regular customers, but trans- 
actions between dealers were almost altogether dis- 
continued. In normal times, by offering to buy 
exchange at higher prices, a dealer can secure what- 
ever amount he may require. At such times changes 
in rates serve to adjust supply and demand in the 
exchange market. Beginning with Monday, July 
27, rates merely reflected the urgent and even fran- 
tic efforts of particular purchasers to secure ex- 
change. Rates fluctuated widely, but as each trans- 
action stood by itself they had no general market 
significance. 

218. THE WAR AND THE LONDON 
SIGHT RATE.— Through the assistance of the 
British Government, London was able to resume, 
toward the end of August, 1914, both the accepting 
and discounting of bills. But a few months later a 
new cause of difficulty presented itself. Sterling 
exchange, which throughout the world had ruled 
far above par for some time after the outbreak of 



LOANS AND INVESTMENTS 247 

the war, gradually began to decline, at first slowly, 
then more rapidly, until it was far below the gold 
export point from London. By August, 1915, ster- 
ling exchange in New York had dropped to $4.50, 
and fluctuated widely over short periods of time. 
In other words, the base rate from which rates on 
all time bills are calculated no longer fluctuated 
within narrow and definite limits between the ex- 
port and import points. It consequently became an 
unsatisfactory medium in which to enter into con- 
tracts for payment at a future date. This unsatis- 
factory position of the sterling rate was due to the 
enormous importations of supplies to Great Britain 
on account of the war. Toward the end of 1915 ar- 
rangements were finally made for financing these 
purchases largely through the negotiation of loans 
in the United States; and thereafter the sterling 
rate was pegged at about $4.76. The establish- 
ment of a stationary base in this artificial manner 
could not, however, give that confidence in sterling 
which it enjoyed when subject only to slight 
changes due to normal trade and credit influences. 
219. DEVELOPMENT OF DOLLAR EX- 
CHANGE.— The European war, it will thus be 
seen, created conditions favorable to the develop- 
ment of the business of drawing bills of exchange 
on other markets than London, and in particular on 
New York, the most important financial centre in 
neutral countries. Fortunately the power to accept 
bills of exchange, had been granted to the national 



248 LOANS AND INVESTMENTS 

banks by the Federal Reserve Act of 1913, and also 
to State banks and trust companies in a number of the 
States. Moreover, after the disturbance occasioned 
by the outbreak of the war had been overcome, dis- 
count rates in New York fell to a level distinctly 
below that in London. Under these favorable cir- 
cumstances American bankers entered the foreign 
exchange field as acceptors and lenders. Commer- 
cial letters of credit providing for the acceptance of 
bills payable in dollars have proved satisfactory 
both to American and foreign traders. As a factor 
in creating the existing demand for Dollar Credits, 
the establishment of American branch banks abroad 
cannot be emphasized too strongly. Through these 
branch banks, a new and adequate medium for the 
liquidation of transactions as between the United 
States and certain foreign countries has been placed 
at the disposal of American merchants. A direct 
channel is now open to the ebb and flow of credit 
transfer between the United States and the coun- 
tries mentioned, and, as a natural sequence, the 
former disparity existing against the Dollar, as 
compared with Pound Sterling and the principal 
Continental exchanges, has disappeared. The re- 
sulting equalization in the rates of exchange 
benefits the American merchant to the extent of 
relieving him of the charges formerly paid to the 
indirect channels of liquidation, or, in other words, 
to the foreign banker. The Dollar Credit is of 
capital importance to every American merchant 



LOANS AND INVESTMENTS 249 

who is interested either directly or indirectly in 
the importation of commodities of any character. 
A study of the advantages accruing from this form 
of credit will demonstrate the desirability of its 
general employment as the vehicle for financing 
not only our own imports but also those of other 
countries. Primarily, it is more economical than 
the Sterling or Continental Credit, for the initial 
commission cost of issuance is lower. Secondly, 
it is based on a known quantity, the Dollar, a fac- 
tor of supreme importance in these days of extreme 
and violent fluctuations in the exchange rates, and 
therefore all exchange risk is eliminated from the 
operation as far as the importer is concerned. 
Maturities drawn under Dollar Credits are due and 
payable in Dollars on a given date, and no question 
arises as to what the exchange rate on London 
may be 90 days after acceptance of the bill. 

220. FOREIGN EXCHANGE AFTER THE 
WAR. — It is advantageous, both to importers and 
exporters, to have bills drawn on a single central 
world market, rather than on cities in each of the 
countries with which they are trading. There has 
been a broad market everywhere for sterling bills, 
because not only trade with England but with all 
countries has been handled by means of bills drawn 
on London. If a prolonged period of peace is to 
be anticipated at the close of the present war, the 
supremacy of London foreign exchange market will 
probably continue. On the other hand if national 



250 LOANS AND INVESTMENTS 

enmities are to be continued and strife is merely 
transferred from the battle field to the market place, 
the convenience of a central money market will pre- 
sumably not be sufficient to warrant the risk in the 
event of further outbreaks. Moreover, if interna- 
tional trade is to be developed by national organiza- 
tions, primarily for national objects, rather than for 
individual profit, it will be necessary for each im- 
portant country to organize the financial machinery 
needed for handling its own trade. 

221. NATIONAL FOREIGN TRADE POL- 
ICY. — Foreign trade is to be an ever increasingly 
important factor in the future development of 
America. The banker's interest in this develop- 
ment is vital not only to himself, but to the citizen- 
ship of his country. The close relationship of 
banking and foreign trade and national welfare is 
clearly set forth by F. A. Vanderlip, President of 
the National City Bank of New York, in the follow- 
ing words: 

(1) "There is a disposition sometimes to compare do- 
mestic trade with our foreign business and to say that, after 
all, foreign trade is a small matter, and we have field enough 
at home. I want to try to show the dangerous narrowness 
of that view by drawing some illustrations from the bank- 
ing situation. A bank's reserve is the cash which the banker 
has in his vault. That, in the main, must be gold, and is, in 
fact, all gold, or its representative, the gold certificate, ex- 
cept a moderate amount of United States notes and silver. 
The foundation of all banking credit is the gold reserve. 
The structure of banking credit must stand on that founda- 



LOANS AND INVESTMENTS 251 

tion, and its size is directly governed by the amount of re- 
serve the banks hold. 

(2) "I could visually illustrate the relation, which you 
all already understand, if I had a flat disc of gold and some 
sand. I could pile sand on that flat disc of gold to a perfectly 
definite amount, governed by two factors, the size of the disc 
and the angle at which the sand would lie undisturbed. 
Suppose we let that angle be the measure of our legal re- 
serve requirement. In the passage of the Federal Reserve 
Act that angle was increased when we lowered the ratio of 
reserve that banks must hold. We are now able to base a 
taller structure of banking credit upon a given gold basis, 
and to do so safely, than we were before the Federal Re- 
serve banks were created. 

(3) "Now, the tendency in every bank management is 
to loan money so long as sound borrowers can be found and 
the bank has in its vault idle funds above its legal reserve 
requirements. That is to say, on our gold disc will be piled 
all the grains of sand, letting them represent loans, that can 
be placed there. If our gold disc is enlarged, the amount of 
sand we can pile on it is increased eight or ten times as much 
as the amount of fresh gold added to the gold base, for the 
structure of bank credit normally bears a relation, taking 
the country as a whole, of eight or ten times the size of the 
gold reserve. Now, conversely, if through any banking 
operation the gold reserve is reduced the same thing will 
happen to the structure of bank credit as must happen to my 
pile of sand if I decrease the diameter of my gold disc. 
Credits must be reduced approximately ten times the 
amount that the gold base is reduced. It was a recognition 
of this principle and an appreciation of the havoc which it 
plays when reserves are rudely disturbed which led to de- 
vising the Federal Reserve Law and the mobilization of all 
reserves, so that we cannot again have just the sort of dis- 
turbance, and even panics, that used to follow the normal 



252 LOANS AND INVESTMENTS 

seasonal shipment of reserve money out of the financial 
centers for crop moving operations. We have safeguarded 
that danger, but we have not altered the principle, and if 
the country faces a situation where, through any other 
process, the gold reserve may at one time be greatly aug- 
mented and the credit structure built full-sized upon it, and 
then through the operation of trade balances, if gold is drawn 
out from under that credit structure, the credits must be 
reduced in corresponding ratio as surely as the pile of sand 
upon the gold disc would decrease if we began to clip from 
the edge of the disc the foundation upon which the sand 
stood. 

(4) "So much for 'the illustration! Now, what is it that 
we have seen happen since the outbreak of the war in our 
domestic banking situation? There have been two factors 
that worked toward an increased credit structure. The 
Federal Reserve Law, reducing reserve requirements, went 
into effect, that is to say, the angle at which the sand lay on 
the gold disc was increased, and we have had an enormous 
influx of gold ; in other words the gold disc was greatly en- 
larged. The result was easy to foresee. Bankers always 
loan an idle surplus if they can, and it is not surprising then, 
if we turn to statistics, to see that the loans and discounts of 
National banks alone have gone up more than a billion 
dollars and for all the banks the total would not fall far 
short of two billion dollars. Our heap of sand on the gold 
disc is about one-sixth larger than it was when the war 
broke out. 

(5) "What is going to happen to that gold disc when 
the war is over? What defense have we for our gold re- 
serve? What program of preparedness are we working out 
to meet the international attack that is threatened to be 
made upon the gold foundation of our credit system? Do 
you recognize why that question is of vital interest to every 
citizen, to every man with a bank account? The interior 



LOANS AND INVESTMENTS 253 

farmer, merchant or manufacturer, wholly local in his inter- 
ests, may think he has but the remotest interest in foreign 
trade; he is, however, interested in bank reserves, and the 
course of foreign trade as it reacts on those reserves will 
affect his business future to an extent that may some day 
amaze him. 

(6) "So long as the war goes on the world will be so 
tipped askew, in all probability, that the gold holdings of 
other countries will continue to fall into our lap. As the 
gold falls it will be added to our reserves. As those reserves 
grow, so will grow our credit structure based upon them. 
When the war is ended, we will find all Europe depleted of 
its gold, staggering under a weight of inflated bank and 
government paper, and under the direst stress to rebuild 
its stock of gold. The point of attack will be our gold re- 
serves. The methods will be every means known to trade 
and commerce by which merchandise, securities and credits 
can be exchanged for gold. The laws of political economy 
will be on the side of the attack. A plethora of gold, such as 
we will have always means rising prices. We will establish 
a price basis here which will make us a good market to sell 
in and a bad market to buy in. We are now advancing our 
labor costs, and that and every other element that enters 
into production will, under the influence of this gr # eat in- 
crease in our gold reserves, tend toward high market values. 

(7) "If we find ourselves, when conditions start again 
toward the normal, to be the market where prices are the 
highest, where the cost of production is the greatest, and 
where the interest rate is the lowest, the road will be open 
for attack upon our gold reserves. If that attack is suc- 
cessful, then the whole credit structure that will have been 
reared upon it must be rudely reduced, for the reduction in 
credits must be manyfold greater than the loss of gold. What 
defense can we put up? How can we safeguard ourselves? 
We have recognized the principle and safeguarded ourselves 



254 LOANS AND INVESTMENTS 

in a domestic way by the enaction of the Federal Reserve 
Law, but there can be no safeguarding by law from an inter- 
national attack upon our gold stock. Other means must be 
found than any that could be provided by legislation. Nor, 
do the means lie in the hands of the bankers. They may rec- 
ognize the danger, and, instead of loaning to the limit per- 
mitted by law, run with strong reserves; but any surplus 
that we could expect the bankers to hold would suffice for 
but a short time if the drain were severe. We may invest 
in short term foreign loans that can be converted into credits 
to check a gold demand. We have already done some of 
that and will probably do a good deal more. There have 
been bankers so short-sighted as to object to our making any 
loans abroad, but I believe the day will come when you will 
find that those loans, convertible into credits, — as they will 
be, — will form a check to gold withdrawals, and be one of 
the most important safeguards of our gold stock. But efforts 
in the way of defense, such as excessive reserves or short 
term foreign investments, must be as nothing when com- 
pared to what is possible in the form of credits created by 
exports of produce and merchandise. There is the strength 
of our defense. Its effective measure will be the size of our 
exports compared to our imports. The size of that favorable 
balance must form the true defense of our gold stock. That 
is why every citizen, whether he knows it or not, is inter- 
ested in the subject of National trade policy." 



CHAPTER VII 



Bonds and Circulating Notes 

222. BANK NOTES AND DEPOSITS.— 

There has been a general failure in popular discus- 
sion of banking to recognize the identity of the note 
and the deposit so far as they relate to the bank 
itself. There may be a difference of opinion about 
the comparative effects of notes and deposits upon 
the level of prices and the general business of the 
community, but none about their relationship to 
the bank. If the borrower presents himself at a 
bank for accommodation, has his security accepted, 
and his loan granted, there is no theoretical differ- 
ence so far as the bank is concerned whether it 
credits him with $1,000 on its books and allows 
him to draw it out at pleasure, or to transfer it 
to others, or whether it hands him a package of 
one thousand one dollar demand notes, which he 
may present at sight for payment, or which he may 
hand to one thousand other persons, who may pre- 
sent them if they choose. Whether the bank has 
credited the borrower with $1,000, or has given 
him one thousand one dollar demand notes (or 
"bank notes"), it is in exactly the same position 
so far as the outside world is concerned — that is to 
say, it has accepted the borrower's note for $1,000 
and in return has given him a sight claim for $1,000 
upon itself, the consideration being a rate of interest 

255 



256 LOANS AND INVESTMENTS 

of specified amount. The bank note must, there- 
fore, be looked upon from the standpoint of bank- 
ing just as is the bank deposit — as a sight liability. 
223. RELATION OF NOTES TO CUR- 
RENCY. — The note, when once issued, differs 
from the deposit in its practical effect upon the 
bank only in respect to the time it remains in cir- 
culation. It is plain that $1,000 in notes paid out 
by a bank over its counter may be almost immedi- 
ately placed on deposit with it, in which case all 
that has happened has been that the bank has ex- 
changed one form of liability for another form. 
But such an issue of notes may remain in the hands 
of individuals for a great while. If there is absolute 
confidence on the part of such individuals that the 
bank is solvent and able to pay its obligations, and 
if there is a shortage of currency in the community 
so that the bank notes fill a convenient place, the 
life of the notes may be very long. In case of the 
deposit, the existence of the credit upon which that 
deposit is based may be equally long. Thus, if a 
single bank does the business of a given community, 
and grants a credit of $1,000 to a borrower, who 
secures a renewal of his credit from time to time, 
it is possible that this credit may be indefinitely 
continued, while the claim on the bank may be 
passed from hand to hand in the form of checks. 
As a matter of fact, a check does not pass many 
times before it is presented for redemption, while 
the practice of commercial banks is not to grant too 



LOANS AND INVESTMENTS 257 

frequent or too long renewals of credits. This 
means that any given draft upon a deposit is not 
likely to remain long in existence, while the credit 
which brought it into existence is itself likely to 
be terminated at a comparatively early day. 

224. BANK NOTES AND CHECKS.— The 
same thing is true of the loan on the strength of 
which bank notes are issued, but the bank note 
itself may pass from hand to hand a great many 
more times than would a check for an equal amount. 
In other words, the circulation activity of the bank 
note is likely to be much greater than that of the 
deposit of equal face value. This means that the 
bank note has a somewhat different status as cur- 
rency from that which is occupied by the deposit 
subject to check. How far the currency activity 
of the note affects prices in a way different from 
the influence exerted by the deposit need not be 
discussed at this point, it being a problem of money 
rather than of banking. The fact remains that the 
bank note performs a "currency function" which 
has generally been considered more important than 
that of the deposit. If a given volume of bank 
notes is, on the average, maintained in circulation 
in any given country, such volume evidently dis- 
places an equal amount of some other form or 
forms of currency or coin. This may be a desirable 
feature of the bank note system, inasmuch as it 
substitutes a credit instrument of comparatively 
low cost for a costly circulating medium like gold. 



258 LOANS AND INVESTMENTS 

225. PROTECTION OF NOTES.— Because 
of this "currency function," it has been felt by 
legislators in most countries that the issue of bank 
notes ought to be controlled with great care, and 
as a result numerous methods for restricting note 
issues have been attempted. This protection may 
take, and does in practice take, several different 
forms. One of the most familiar forms is the 
limiting of the total amount of bank notes to be 
issued by a given institution. A second mode of 
protecting the note-holder is that of setting aside 
a special security for the protection of notes. Thus 
banks may be directed to invest in a given kind 
of bonds a sum equal to the amount of the notes 
they issue. This type of control is seen in the 
National banking system. Coupled with this (as 
seen in the National banking system) may be a 
provision that the notes shall be a first lien upon 
the assets of the bank which issues them. A third 
method of protecting a note issue may be the flat 
guarantee of the government which has chartered 
the issuing bank that in the event of the failure of 
such bank it will assume a responsibility for its 
notes. A fourth mode of protection may be found 
in regulations designed to control the classes of 
security which shall be held by banks behind their 
notes. Thus banks may be directed not to issue 
more notes than are protected by given classes of 
commercial security. This has the effect of limit- 
ing note issues beyond a certain point to those 



LOANS AND INVESTMENTS 259 

classes of loans in which the specified kind of 
security can be obtained. A fifth mode of protec- 
tion is seen in the establishment of peculiar 
facilities for redemption of notes and for assuring 
their prompt return to the bank which put them out. 

226. WHY NOTES ARE ISSUED.— The 
issue of bank notes is taken as so much a matter 
of course that the reason for their issue is not 
usually considered in much detail. In fundamental 
analysis, of course, the notes come out for exactly 
the same reasons which govern the creation of 
deposits — someone secures a loan from the bank, 
and the credit corresponding thereto is granted in 
the form of a note issue. But this does not explain 
the selection of the note as compared with the 
deposit. There must be some reason determining 
whether a note will be handed to a borrower or 
whether a credit of like amount will be written in 
a pass book. This is usually a question of business 
convenience merely, and as such is to be settled by 
the borrower (always supposing that the bank is 
able to issue the note if it chooses, under the exist- 
ing law). The borrower may prefer notes because 
of their greater acceptability to the person or per- 
sons to whom they are to be paid. 

227. THEORY OF NOTE ISSUE.— From 
what has been said it is clear that the theory of 
note issues in their relation to the bank is identical 
with that of deposits and their relation to the bank. 
There is in fact no distinction to be drawn in this 



260 LOANS AND INVESTMENTS 

respect between the note and the deposit. The 
putting out of an issue of notes will be considered 
by the bank under exactly the same terms and con- 
ditions as those which have controlled it in regard 
to the creation or grant of a line of credit based 
on deposits. The classes of security accepted by 
the bank when it is asked to make an issue of notes 
are the same as those which it will accept when 
granting a loan in the form of a credit on its books. 
The protection of the bank against loss depends 
entirely upon the security which it receives, and 
the standing of the borrower who gets the loan. 
There is no special profit in the issue of notes that 
does not inhere in the creation of deposits. 

228. SECURITY FOR BANK NOTES.— The 
question whether note issues should be given any 
ultimate security different from that possessed by 
the other liabilities of the bank has been consid- 
erably discussed and opinions vary widely with 
reference to it. Probably the best opinion of the 
day is that no such special security is desirable, 
but that the safety of the note-holder is to be pro- 
vided for by means of prompt and active redemp- 
tion and by confining the issue of notes to banks 
whose capital is large enough and whose methods 
are sound enough to assure the note-holder and 
the government that there will be a high degree 
of responsibility on the part of the institution. This 
idea is carried a step further when provision is 
made (as in the Canadian banking system) for 



LOANS AND INVESTMENTS 261 

making the banks jointly liable for the notes of 
all insolvent banks. In the case of the Canadian 
banks, the result is accomplished by compelling 
banks which desire to issue notes to put up a jointly 
contributed fund called a "guaranty fund" on which 
the notes of any insolvent bank may, under certain 
circumstances, be made to draw. The result of 
such a provision is to make banks exercise an over- 
sight over one another's issues and to create a 
probably higher degree of watchfulness than would 
exist were the banks severally, but not jointly, 
liable for the outstanding notes. 

229. BONDS AND BANK NOTES.— Such a 
system, however, is entirely different from one in 
which a bank is compelled, before issuing any notes, 
to lay aside a part of its assets in a segregated fund 
for the purpose of protecting the note issue based 
thereon. This is the system employed under the 
National Bank Act of the present day and has 
proved to be unsatisfactory. Every National bank 
upon being organized was originally required to 
buy an amount of bonds dependent upon the amount 
of its capitalization, and to deposit these bonds 
in trust with the Treasurer of the United States. 
Upon so doing, the bank was permitted to receive 
bank notes to an equal amount, and could then dis- 
pose of these as it pleased, using them in loans to 
borrowers. Should the bank fail, the notes could 
be provided for by selling the bonds and thus 
establishing a fund for their cancellation. The 



262 LOANS AND INVESTMENTS 

Federal Reserve Act repealed the provision re- 
quiring such purchases of bonds by banks. Inas- 
much as United States bonds have always been of 
high standing in the market since the system of 
note issue referred to was first established, there 
has never been a time when anyone felt the slight- 
est question about the ultimate goodness of the 
National bank note. This very secure character 
has, however, been obtained at considerable cost, 
since the use of United States bonds has rendered 
it very difficult to get the notes into circulation 
when they were wanted and conversely has made 
it hard to retire them when they were not wanted. 
230. STATUS OF AMERICAN NOTE CUR- 
RENCY. — It has been a principal cause of com- 
plaint of the existing currency situation in the 
United States for many years past that our medium 
contained no element corresponding to what is 
known as the "elastic" bank note issues of other 
countries. There have been many kinds of cur- 
rency in circulation, the principal being as follows : 

(1) United States notes or greenbacks, legal 
tender in payment of debts. 

(2) Gold certificates representing actual gold 
coin held as a trust fund in the Treasury. 

(3) Silver certificates representing silver coin 
held as a trust fund against them in Washington. 

(4) Currency certificates representing United 
States notes held as a trust fund in Washington or 
at sub-treasuries to facilitate bank exchange. 



LOANS AND INVESTMENTS 263 

(5) Gold coin, legal tender in payment of debts. 

(6) Silver dollars, legal tender in payment of 
debts. 

(7) Silver subsidiary coin, legal tender in pay- 
ment of debts up to $5. 

(8) Minor coins of limited legal tender quality. 

(9) National bank notes issued by the banks 
and protected by Government bonds deposited with 
the Treasury Department. 

231. INELASTICITY OF CURRENCY.— It 
is easily seen that of ail these classes of currency 
and money which have been in circulation none 
could be increased save by the actual bringing of 
metal to the mint for coin, with the exception of 
National bank notes. The latter could be enlarged 
in volume by the deposit of Government bonds and 
the placing of a 5 per cent, redemption fund with 
the Treasury Department. Even in the latter case, 
however, it is clear that the amount of National 
bank notes which could be issued was limited in 
the aggregate amount by the total volume of United 
States bonds in existence, and was still further 
limited by the fact that many such -bonds were held 
and used to protect public deposits, while still 
others were held by investors, and so were not' 
available for circulation purposes. As the National 
bank currency had increased in amount until it 
absorbed practically all of the available volume of 
bonds, it has been apparent at certain times in the 
past that a great demand for notes could not be 



264 LOANS AND INVESTMENTS 

satisfied by the taking out of bank currency. In 
order to overcome the "inelasticity" of practically 
every element in the currency system various plans 
have been proposed. 

232. SUFFICIENCY OF PROTECTION.— 
The experience of other countries and the theory 
of banking both combined to indicate that there is 
no sound reason for differentiating between the 
protection accorded to notes and that accorded to 
deposits; but that which is sufficient in one case 
should be sufficient in all others, and that this (as 
the experience of our nation indicates) should be 
the best constituent of the assets of the banks — « 
namely, sound, short time commercial paper. The 
difficulty in applying this standard has been two- 
fold. 

(1) It has been contended that there was not 
sufficient sound paper of the kind required in the 
United States. 

(2) It has been urged that existing bank notes 
could not be displaced on account of the injustice 
to the banks which had bought bonds to deposit 
as security for the notes, and for other reasons. 
The problem, therefore, of those who wished to in- 
troduce a more satisfactory method of issuing new 
currency has been that of protecting the owners 
of existing bonds and at the same time of furnishing 
an adequate basis for new note issues in the shape 
of undoubtedly sound commercial paper. To attain 
these objects there have been many complicated 



LOANS AND INVESTMENTS 265 

plans in the past, and an additional element of com- 
plexity has been added by reason of the attempt 
usually made to introduce special means of insuring 
the safety and goodness of the notes. 

233. NOTES UNDER THE FEDERAL RE- 
SERVE ACT.— When the Federal Reserve Act 
was in process of drafting, all these considerations 
were taken under advisement, and it was thought 
best to provide for the proper treatment of existing 
note currency as well as for the issue of new notes. 
Originally the Federal Reserve Act provided for 
the refunding of existing bonds — that is to say, 
the exchange of the bonds now outstanding for 
new bonds to bear three per cent, interest, 
and the gradual retirement of National bank 
currency as this refunding proceeded. Provision 
was also made for the issue of bank notes by 
the several Reserve banks based upon the deposit 
of commercial paper of the kind made eligible for 
rediscount under the terms of the laws; and the 
general purpose contemplated by the measure was 
that in the course of twenty years existing National 
bank notes should be retired, and new Federal Re- 
serve notes should take their place. 

234. CLASSES OF NOTES.— While the Act 
was under consideration in Congress alterations 
were introduced into it, and the machinery by which 
the purposes of the Act were to be fulfilled was 
altered, although it may be broadly said there was 
no change in the objects ultimately aimed at. Prob- 



266 LOANS AND INVESTMENTS 

ably the most important alteration thus made in 
the terms of the law was that which designated 
the new Federal Reserve notes as obligations of 
the United States, thus making them, in the techni- 
cal sense at least, a Government currency. Another 
important innovation was a provision whereby 
Federal Reserve banks might be required by the 
Federal Reserve Board to buy National bonds held 
by member banks at a rate not to exceed $25,000,000 
per annum, while they were to be permitted to issue 
a new kind of currency to be known as Federal 
Reserve bank notes on the strength of the bonds 
which they thus acquired. It will be seen that the 
Act, therefore, provides for two new classes of 
currency : 

(1) Federal Reserve notes. 

(2) Federal Reserve bank notes. 

The former are protected by commercial paper of 
the kind rendered eligible for rediscount under the 
terms of the law; the latter are protected by Na- 
tional bonds purchased from the member banks 
of the System, or any other Government bonds 
having circulation privileges. The ultimate form 
of the Federal Reserve Act, however, provides for 
the conversion of two per cent, bonds into three 
per cent, bonds by Federal Reserve banks; such 
three per cent, bonds, moreover, to lose their privi- 
lege of deposit with the Government to protect 
circulation. 

235. PROCESS OF CONVERSION.— It will 



LOANS AND INVESTMENTS 267 

thus be seen that, under the terms of the Federal 
Reserve Act, the natural development would be 
conversion in a period of years of most of the 
National bank notes into Federal Reserve bank 
notes, with accompanying retirement of these 
notes, through the conversion of the two per cent. 
bonds protecting them, into three per cent, bonds; 
while, in the meantime, Federal Reserve notes based 
on commercial paper would be issued from time to 
time as demanded, in quantities sufficient to supply 
the elastic element in currency, and to fill up such 
gaps in existing National bank notes as might be 
caused through the retirement of note issues due 
to the conversion of two per cent, into three per 
cent, bonds not bearing the circulation privilege. 

236. DEMAND FOR NOTES.— It is now 
time to see how this technical proceeding works 
in practice, and what will be the effect of it upon 
the average man the country over. Let us first 
observe with some care exactly what gives rise to 
a demand for currency and to consequent issues of 
Federal Reserve notes. When A trades with B 
to the extent of $100,000 worth of goods he thereby 
creates a demand for some means of transferring 
the value of $100,000. This exchange may be made 
by the actual use of money, or by the drawing of 
a check. Where the buyer of the goods does not 
have the means to pay for them he usually applies 
to his bank for accommodation, and such bank may 
meet his requirements by giving him a credit on 



268 LOANS AND INVESTMENTS 

its books, technically known as a "deposit," or by 
issuing to him its own notes or the equivalent there- 
of. There is no reason why the bank which is thus 
applied to, if it desires to grant the credit at all, 
should not give the accommodation in either form 
that may be desired by the customer. The cus- 
tomer is likely to be governed entirely by the 
demand of the people with whom he is dealing as 
to the form of payment required. In the case of the 
bill of goods for $100,000 already spoken of, it is 
probable that a check on the bank would be exactly 
what he wanted, in which case no question of note 
issue is raised. But it may also be that the funds 
are not wanted for a single payment of this kind, 
but that accommodation is sought for some purpose 
which necessitates a number of small payments to 
persons who do not or cannot employ bank checks. 
In this instance notes would be needed. Or it may 
happen that a bank discounts some paper for the 
purpose of obtaining currency with which to supply 
actual calls for currency made by its customers who 
are not necessarily borrowers but who want notes 
to carry in their pockets for the purpose of meeting 
demands from day to day. 

237. NOTES AS NEEDED.— What the Fed- 
eral Reserve Act does is to permit a bank to take 
the promises of individuals to pay at the end of a 
designated period, indorse these promises with its 
own signature, and, by the deposit of them with 
the Federal Reserve bank, obtain in exchange 



LOANS AND INVESTMENTS 269 

Federal Reserve notes issued to that bank by a 
Government officer known as a Federal Reserve 
Agent. The fact that these notes are technically 
obligations of the Government confuses the situa- 
tion to some extent, because it makes the transac- 
tion appear as if it were one which involved the 
Government in some way. As a matter of fact, 
it is the member bank's demand which gives the 
signal for the issue of the notes and determines how 
many of them shall come out; while it is the 
demand of the customer of the member bank which 
influences the action of that bank in applying for 
them. Ultimately and in broadest terms, then, the 
provision of the Federal Reserve Act simply allows 
individuals to make their own obligations based on 
commercial, industrial or agricultural transactions, 
and then, by putting these through a local bank, to 
get note currency corresponding thereto. As long 
as their credit is good they can get the notes, pro- 
vided that the Federal Reserve bank is in a position 
to protect these notes amply with gold. Under the 
terms of the Federal Reserve Act this protection 
must amount to at least 40 per cent, of the face of 
the note issue; and of this 40 per cent, five per 
cent, is deposited with the Treasury Department 
for current redemption, the other 35 per cent, being 
held in the vaults of the Federal Reserve bank 
which issues the notes. The currency is thus elastic, 
inasmuch as it can be increased to the extent of 
two and one-half times the supply of gold available 



270 LOANS AND INVESTMENTS 

— 100 per cent, being two and one-half times 40 
per cent. — while it is safe, inasmuch as the protec- 
tion is adequate for all ordinary requirements. 
Nothing limits the amount of notes that can be 
issued, therefore, except the needs of the business 
community and the adjustment of the country's 
gold supply to that of other nations. 

238. FEDERAL RESERVE BANK NOTES. 
— The Federal Reserve bank note differs from the 
Federal Reserve note in that it is based upon 
Government bonds which are deposited with the 
Treasury Department to safeguard it, just as is 
the case with National bank notes. The Federal 
Reserve bank, under the provisions of the Federal 
Reserve Act, is permitted to buy Government bonds 
as a form of investment if it chooses to do so. In 
addition to this, Federal Reserve banks in the ag- 
gregate may be assigned by the Board Govern- 
ment bonds to an amount not to exceed $25,000,000 
per annum, and may be required to purchase them 
and pay for them at par. Such assignment takes 
place only in the event that member banks desiring 
to sell their bonds file application with the Treasury 
Department for the disposal of these bonds and the 
retirement of circulation based thereon. If the 
aggregate of such applications should be more than 
$25,000,000 per annum, the Federal Reserve Board 
apportions the purchases among the banks by a 
method prescribed in the law, which amounts to a 
distribution according to capital and surplus. In- 



LOANS AND INVESTMENTS 271 

asmuch as the banks which thus seek to exchange 
their bonds are, of course, unable to get back the 
notes that were issued on these bonds (the latter 
being in circulation throughout the country), this 
provision of the law amounts to permitting the 
member banks to transfer to the Federal Reserve 
banks up to the amount of $25,000,000 a year, such 
Government bonds with the circulation privilege 
as they may have in their possession pledged to 
secure National bank notes, the Federal Reserve 
banks becoming thereupon obligated for all out- 
standing National bank notes previously issued 
against them. Of course, the transaction would 
not occur in precisely this way, as the Federal 
Reserve bank would pay for the bonds, and the 
money would go into the Treasury, there to be held 
against the outstanding bank notes which had been 
issued on the strength of these bonds. The Federal 
Reserve bank would then be able to issue its own 
notes against the bonds so taken over if it saw fit, 
as it doubtless would; but the result would be 
the same. 

239. TIME OF RETIREMENT.— It is easy 
to see that if this process went on for about thirty 
years at the rate of $25,000,000 per annum, all of 
the National bonds would have been taken over by 
the Federal Reserve banks, the National bank notes 
based thereon retired, and an equal amount of 
Federal Reserve notes issued in their place. We 
should then have this underlying sub-structure of 



272 LOANS AND INVESTMENTS 

Federal Reserve bank notes (or, in the interim, of 
Federal Reserve bank notes and National bank 
notes combined) ; while above would be a super- 
structure of Federal Reserve notes based on re- 
discounted commercial paper, and varying in 
amount according to the needs of the country. How 
great are such needs? They are, of course, only 
temporary and exceptional, inasmuch as the regu- 
lar, steady, permanent demands are met by the 
underlying structure of bond-secured notes. These 
varying demands are in part the result of so-called 
"seasonal" calls, for the moving of crops and the 
like, and in part the result (at special times) of 
so-called "panic" demands. There is no positive 
information as to the actual amount of the seasonal 
demands for crop moving. They vary greatly ; and 
as long as there is in existence a large underlying 
body of notes, there will always be more or less 
shipment of currency from one part of the country 
to another to meet seasonal calls. 

240. PANIC DEMANDS FOR CURRENCY. 
— The extent of the panic demands can be estimated 
on the basis of experience obtained during the 
autumn of 1914. At that time calls were made on 
the Treasury Department under the section of the 
Federal Reserve Act which extended the operation 
of the so-called Aldrich-Vreeland Law through 
local "currency associations," for sums aggregating 
about $386,000,000. This was the result of an 
extremely severe currency demand, and under no 



LOANS AND INVESTMENTS 273 

ordinary conditions would again be witnessed. If 
we estimate the ordinary normal seasonal demands 
at one-third of this amount, it would probably be 
an amply high figure. It may be stated, then, that 
when the Reserve System is in full operation there 
may be a call for from $125,000,000 to $375,000,000 
of Federal Reserve notes, the amount varying ac- 
cording to conditions. At the end of 1915 there 
were outstanding about $214,000,000 of Federal 
Reserve notes, while of this amount all except some 
$16,700,000 was protected by deposits of gold or 
lawful money dollar for dollar. There can be no 
doubt that the quantity of legitimate commercial 
paper in current existence is ample to sustain even 
the maximum demand for currency thus indicated, 
so that it may truly be said that the Federal Reserve 
System is fully able to supply an elastic currency 
issued to any reasonable amount that may be called 
for. The only limitation upon the currency is the 
demand of the community and the existence of 
actual live transactions calling for it. 

241. POLICY OF NOTE ISSUE.— Many who 
speak of the currency question seem to think that 
it is desirable for the Federal Reserve banks to 
force out into circulation, and to keep out, as large 
a volume of circulating notes as possible, obtaining 
in exchange therefor the gold of the community. 
Thus it is often argued that it would be desirable 
to permit member banks to count Federal Reserve 
notes as reserves in their own vaults, the effect 



274 LOANS AND INVESTMENTS 

being to make them willing to hold the notes there, 
and to deposit their cash means with the Federal 
Reserve bank, which in turn would use these means 
as a reserve basis protecting other liabilities — notes 
and deposit accounts. Such a view, of course, 
ignores the theory upon which the Federal Reserve 
Act is founded — the so-called "banking theory," 
as opposed to the "currency theory." The banking 
theory implies that notes are put into circulation 
simply for the purpose of facilitating the exchange 
of goods, and that when this purpose has been 
fulfilled they should pass out of existence. Bank 
notes, according to this view, are not a means of 
displacing gold and enabling the hoarding of the 
latter metal, but are a means of providing a sub- 
stitute for gold for the purpose of making ex- 
changes, such substitute to continue in use so long 
as there is an actual demand for it for the transfer 
of goods, and then to go out of use as soon as this 
demand has been satisfied. 

242. FEDERAL RESERVE NOTES AND 
BANK RESERVES.— It is often pointed out that 
the Federal Reserve notes, not being legal tender 
and not being reserve money, can, at the will of the 
holder (if a bank) be promptly converted into 
reserve funds by the simple process of depositing 
them with the Federal Reserve bank which issued 
them. Therefore, it is argued, the wise course 
would be that of making the Reserve note legal 
tender to start with, and of permitting it to be used 



LOANS AND INVESTMENTS 275 

in bank reserves. No such conclusion can, however, 
fairly be drawn. When the Federal Reserve note 
is deposited with the Federal Reserve bank which 
issues it, and is thereby converted into a deposit 
credit (reserve), the Federal Reserve bank is given 
a means of tracing and accounting for its liabilities 
at every step. The bank knows when the deposit 
credit is cancelled, and how effectively and under 
what conditions it is transferred. It has entire 
control of its own liabilities in this regard. The 
reserve deposits are not legal tender, but they are 
reserves for the member banks. The member banks 
must provide a legal tender for their own cus- 
tomers, but for their own use they have their credits 
on the books of the Federal Reserve bank. This 
is a situation totally different in theory from that 
which would grow out of a plan such as that put 
forward in the Aldrich or Monetary Commission 
bill — whereby the notes of the reserve institutions 
were made legal tender, and available in the mem- 
ber bank reserves. Under those circumstances 
there would have been nothing whatever to pro- 
duce elasticity. 

243. NOTES BASED UPON BUSINESS 
TRANSACTIONS.— The note issue on its new 
basis will, however, be highly elastic and con- 
trollable. There can be no question of its sound- 
ness and convertibility, and none of its flexibility. 
It is perhaps the most conspicuous feature of the 
new banking system, because the one that has been 



276 LOANS AND INVESTMENTS 

most discussed, but it is far from being the most 
important, in view of the fact that the law, as 
already stated, accepts the banking theory of note 
issue rather than the so-called currency theory. 
"No note issue without a transaction to call for it" 
is the first principle upon which the Federal Reserve 
note issue is based. "No commercial transaction 
that cannot obtain a note issue to facilitate it" is 
the second principle. Taken together, they imply 
that the business community need not in the future 
fear, under any conditions reasonable to expect, a 
deficiency in the circulation. 

244. TAKING OVER GOVERNMENT 
BONDS. — The question exactly how the Federal 
Reserve banks are to proceed in taking over the 
bonds, and the policy of the Treasury Department 
in effecting this great transformation of the cur- 
rency of the country, is a matter of profound inter- 
est to the banker, not only from the general stand- 
point of theory, but also as a matter of affecting 
the value of his assets. More than seven hundred 
millions of dollars of Government bonds are now 
held by the National banks of the country for the 
purpose of sustaining their outstanding notes. The 
great bulk of Government bonds now in existence 
are not of the type which are attractive to the 
public from the investment standpoint, and it is 
fair to say, as a general matter, that they could not 
be sold to private persons, but must be held by 
banking institutions for the most part. Under the 



LOANS AND INVESTMENTS 277 

Federal Reserve Act there are two methods by 
which the National banks now holding these bonds 
may be gradually relieved of them : 

(1) Purchases by Federal Reserve banks in the 
"open market" — that is to say, purchases from any 
individual or institution from whom they may 
choose to buy. 

(2) Assignments or allotments to the Federal 
Reserve banks made by action on the part of the 
Federal Reserve Board, in approving applications 
for the sale of bonds up to $25,000,000 which are 
filed with the Treasurer of the United States by the 
banks now owning these bonds. 

245. PROBLEMS OF CONVERSION.— In 
connection with the administration of the act, 
several matters of a serious nature have called for 
attention. One is the T fact that the act permits 
Federal Reserve banks to go much further than 
their allotment of $25,000,000 annually in the pur- 
chase of bonds, so that the question has arisen, how 
far it would be wise to take over bonds through 
actual purchase. Another question calling for dis- 
position has been whether such purchases would 
constitute a reduction of the amount that might be 
allotted to them by the Board. The Federal Re- 
serve Board, in passing upon this question, has 
taken the view first of all, that actual purchases 
made by the Reserve banks might be counted as 
reducing the amount that could be allotted to them 
as the result of applications for sale made by the 



278 LOANS AND INVESTMENTS 

member banks through the Treasurer of the United 
States. A matter which has been of great import- 
ance from the standpoint of the Reserve banks has 
been whether such bonds as they take over, either 
through purchase or allotment, could be immedi- 
ately converted into three per cent, bonds by the 
Treasury Department, or whether, under the terms 
of the law, they must be partly converted into 
one-year notes, and whether the conversion might 
go on to any amount that the banks chose to 
demand. The decision reached by the authorities 
of the Treasury Department has been that it lay 
within the jurisdiction of the Department to deter- 
mine the amount of bonds so to be converted, and 
the proportions in which the conversion should be 
made into long term bonds and one-year notes. 
For the first year it was determined to convert 
only $30,000,000 of the existing bonds and to make 
this conversion as nearly as possible into equal 
portions of long term three per cent, bonds and 
one-year three per cent, notes. The aggregate, as 
well as the division between bonds and notes, may 
be varied from year to year at the discretion of the 
Secretary of the Treasury. 

246. CURRENCY AND BANK RESERVES. 
— Paul M. Warburg, in an address at the Conven- 
tion of the American Bankers Association, held in 
Kansas City in 1916, said in part: 

(1) "Monetary and banking reform made its greatest 
step forward when public opinion recognized that it was not 



LOANS AND INVESTMENTS 279 

essentially a question of note issues but one o£ reserves. 
But, though this reserve problem has thus been before us 
for many years, it is a strange fact that there still exists a) 
singular confusion in the minds of bankers, writers and; 
students as to what the word 'reserve* actually means in this 
connection. There are all kinds of reserves. There are 
military and naval reserves. We speak of reserves in deal- 
ing with water supply, with food, raw materials, rolling 
stock, electric power, and what not. In each case its mean- 
ing depends upon the requirements of the organization 
maintaining the reserve. Reserve is, as the name implies, 
what one holds back. It generally means an extra supply 
of something kept idle for the purpose of being immediately 
available to take care of an increased demand in excess of 
normal requirements. Now, if we wish to get a clear con- 
ception of the meaning of reserves in connection with the 
Federal Reserve System, we must understand that it is 
necessary to recognize central banks as entirely different 
organizations from commercial banks and trust companies 
and, consequently, that their respective reserves differ as 
much as those of an ice factory and a summer hotel — the 
one a producer and the other a consumer of ice. Reserves 
of central banks and reserves of the general stock banks 
are two entirely different things. For the sake of greater 
simplicity I shall in this address call the National banks, 
State banks and trust companies, the 'stock banks* and their 
reserves 'banking reserves/ and I shall term the reserves of 
the central banks 'gold reserves,' leaving it open at this 
point whether or not these latter reserves should include 
silver and greenbacks. The Federal Reserve System is a 
co-ordination of twelve central banks and the same principle 
as to reserves, therefore, applies as if we were dealing with 
one central bank. I shall, therefore, in this address, class 
the Federal Reserve System with the central banks. 
(2) "Let us consider first the functions of the stock 



280 LOANS AND INVESTMENTS 

banks in central bank countries. Deposit banking is the art 
of wisely employing the depositors' stored-up purchasing 
power. It is based on the principle that there is a sufficient 
variety of conditions amongst the depositors and borrowers 
of a bank so as normally to preclude the probability of the 
depositors withdrawing and using their own money faster 
than it can be collected from the borrowers to whom the 
depositors' purchasing power temporarily has been trans- 
ferred. The bank's own capital and the uninvested part of 
its deposits from the insurance, or reserve, fund to act as 
an equalizer in balancing these scales. It is essentially a 
question of exchanging credits and, where there is a central 
banking machinery enabling the stock banks to liquidate a 
sufficient amount of their assets to make good any deficits 
that may occur, the whole system is safe and complete. The 
central banking organization provides the member banks 
either with balances to be used in the clearing, or, if currency 
should be required, with notes which will be accepted by 
their depositors in settlement of the stock bank's obligations. 
In countries where these notes of the central banks are 
generally accepted in settlement of debts by business men 
and banks, the 'banking reserves' of the stock banks may 
safely consist of the central bank currency or of a balance 
kept with the central bank convertible into such currency. 
These form the first line of banking reserves. The second 
line consists of those assets which, with certainty and 
promptness, may be converted into credit balances with the 
central bank. It is simply a question of having a reserve of 
such credit currency, or of power to produce such credit 
balances, as will provide an acceptable means of satisfying 
depositors. Balances with the central bank, and its notes, 
entitle the stock banks, like any other holder, to payment 
in legal tender ; and if legal tender is demanded by creditors 
a£ the stock banks, the latter must rely upon the central 
bank to furnish it. The duty to keep its own deposit and 



LOANS AND INVESTMENTS 281 

note obligations sufficiently protected by a proper propor- 
tion of metallic cover rests with the central bank, and its 
reserves, therefore, must consist exclusively of the metal in 
which its obligations are payable. In central bank countries 
there does not exist any law that requires stock banks to 
keep in actual specie in their own vaults a certain proportion 
of their deposits. All the central bank usually requires is 
that the stock banks and other firms maintain with it free 
balances commensurate with the scope of their transactions. 
As a matter of fact, if we study the statements of European 
stock banks we find one single cash item which includes 
the combined holding of gold, silver, bank notes and the 
balance with the central bank. 

(3) "In the United States our old State banking systems 
did not provide for any central organization to protect the 
banks' gold obligations, nor did they furnish the machinery 
by which, in case of need, banks could convert their com- 
mercial assets into cash or credit balances. The National 
Bank Act, therefore, required every National bank to main- 
tain against its deposits a certain percentage of actual "lawful 
money reserve, which it was considered should constitute its 
contribution to the general gold protection of the nation ; in 
addition, credit bank balances in reserve and central reserve 
cities were to provide a certain liquidity in case of emerg- 
encies. The vicious shortcomings of this old method are 
well known to everybody here, and need not be elaborated. 
The Federal Reserve Act brought about a most radical 
change. It created a system of twelve central banks which, 
co-operating with one another, were from then on to exercise 
two important functions in relation to their member banks ; 
first, to provide a sufficient gold cover for the country's gold 
obligations ; and, second, to provide the machinery for turn- 
ing, whenever desired, the member banks' commercial assets 
into available credit balances or cash. The first function 
relieved the member banks of the necessity of keeping in 



282 LOANS AND INVESTMENTS 

their vaults large amounts of gold for the general protection 
of the country; the second rendered unnecessary the so- 
called reserve balances with correspondents in reserve and 
central reserve cities. The safe and effectual transfer of 
these burdens to the Federal Reserve banks must be predi- 
cated, however, upon a sufficient mobilization and concen- 
tration of gold in the hands of the Federal Reserve banks, 
and, furthermore, upon the existence of a large volume of 
standardized commercial and banking paper, easily redis- 
countable without red tape with the Federal Reserve banks. 
This is where the Federal Reserve Act stopped half-way. 
It did not say to the member banks, 'Maintain with the 
Federal Reserve bank a minimum balance sufficient for the 
general safety of the country and whatever cash you keep 
in excess of that in your own vaults — be that gold or silver 
or Federal Reserve notes — is your own concern. But bear 
in mind that the larger the gold fund produced by the com- 
bined contributions from your own vaults, the stronger will 
be the protection to you and the entire country.' The law 
continued, instead, the anomaly of requiring member banks 
to lock up in their vaults hundreds of millions of dollars, 
thus preventing them by legal enactment from giving addi- 
tional strength to their own protective system, even if they 
should want to do so. It further created the anomalous 
situation that, while a balance with a Federal Reserve bank 
could be considered as reserve, the Federal Reserve note 
could not be so counted, despite the fact that it is a prior 
lien against the assets of the bank and is the obligation of 
the United States, while the balance is not. This inconsist- 
ency — to a certain extent at least — has been cured ; Congress 
having passed, upon the recommendation of the Board, a 
most important amendment authorizing the Board to permit 
member banks to keep any portion of their required vault 
reserve as balances with their Federal Reserve banks. In 
passing this amendment Congress has opened the path for 



LOANS AND INVESTMENTS 283 

great strides in advance, and it remains to be seen now how 
far the bankers of the United States will be able to seize 
this opportunity of doubling the strength of their Federal 
Reserve banks. 

(4) "In dealing with the problem of adequate reserves, 
we must first and always consider the question of whether 
or not our Federal Reserve banks are sufficiently strong for 
the protection of the country or whether they are stronger 
than necessary. Whenever the latter question can be 
answered in the affirmative, then only will we be justified 
in considering the advisability of reducing the member 
banks' reserve requirements. What is the Federal Reserve 
System's lending power today? If we set aside a gold reserve 
of only forty per cent. — which may do in times of stress, but 
is not a proper and sufficient basis in normal times — we find 
that we have a free gold reserve of about $206,000,000, or i£ 
we include the gold now held in cold storage by the Federal 
Reserve agents, about $380,000,000. This means that by 
additional rediscount operations, or purchases in the open 
market, for home requirements or for export, we are able to 
stand a loss of gold of from two to three hundred million 
dollars. Two hundred million dollars is a very large amount, 
but when we realize that the nation's gold holding in one 
year has increased by about $500,000,000, it is well for us to 
consider whether or not we shall be able to hold this gold 
at the end of the war. It is impossible to predict what will 
then be our economic and financial situation. Perhaps we 
may find ourselves in an overexpanded or generally unsatis- 
factory condition, and we may have to face a readjustment 
in which all our banking strength may be required. On the 
other hand, things may go well with us, but in the rest of the 
world there may be a great deal of financial distress. In that 
case (and it may be the more likely of the two) we shall 
have almost boundless opportunities, but serious obligations 
as well. Foreign loans in the old and the new world may 



284 LOANS AND INVESTMENTS 

draw away our capital at interest rates far in excess of our 
own. Our exporters will have to meet the keen competition 
of other nations, and even though at first there will prob- 
ably be a strong demand for certain of our raw materials, 
the purchasing power of many a country will be found 
materially reduced. These are conditions which, in the long 
run, may be the cause of heavy gold exports from the United 
States and which, if we remain unprepared, may seriously 
check our progress. If, on the other hand, we forearm, we 
may grasp the opportunity of taking our place as the strong- 
est of the world's bankers and furnish our industries with 
the basis for a solid expansion. 

(5) "Does it not appear ridiculous that a country owning 
over two billions and a half of gold should not be able to 
mobilize a larger free gold reserve than two or three hun- 
dred millions of dollars, particularly when it is apparent that 
its future financial and economical growth will depend upon 
the extent of the 'preparedness* that it can provide in this 
respect? Our critics say that, by concentrating the gold in 
the Federal Reserve banks, we shall make them the target 
for gold withdrawals. But they will be that target anyhow. 
The only question is, will they be able to resist without 
being forced to take premature and unnecessarily drastic 
measures of defense? Let us suppose that our member 
banks' excess cash reserves have been wiped out, either by 
gold export or by expansion of the loan and deposit struc- 
ture ; let us suppose that our discount and investment rates 
are fairly low as compared with those prevailing in Europe ; 
let us suppose that our shipments to foreign countries will 
no longer exceed our imports. Then, as money flows where 
it can safely earn the highest returns, our bankers will 
probably have to finance foreign countries both in govern- 
ment loans and individual transactions. Suppose, then, that 
Mr. Ivanoff, in Petrograd, draws $100,000 at ninety days' 
sight on an American banker against a credit granted to him, 



LOANS AND INVESTMENTS 285 

rediscounts that paper in New York, and, against this bal- 
ance, Russia wants gold. Where will it come from? The 
member banks have no more excess reserves ; shall we then 
begin to withdraw it from circulation and how and against 
what? The New York member bank will rediscount $100,- 
000 of bankers' acceptances or commercial paper with its 
Federal Reserve bank and ask for gold. Ultimately, there- 
fore, the demand for gold will be made upon the Federal 
Reserve banks. We are faced with the simple question: 
Will we be strong enough to share our plenty, during the 
coming period of stress, with other nations and be the 
world's banker, or will we be so weak that, when these 
demands come, we must stop them at once by raising our 
discount rates high enough to retain our gold at home? 
Keep all the gold in your vaults where it is useless for your- 
selves and deprived of the additional force that it may gain 
in the hands of the Federal Reserve banks ; keep every cash- 
till in hotels, railroad stations, drygoods stores and what 
not, filled with gold certificates, and you will rob the country 
of its legitimate opportunity of growth, of helping itself, and 
of helping the world. Our foreign competitors will proclaim 
that only a country willing to part freely with its gold may 
safely be accepted as a world's banker, and they will point 
to the fact that, in past critical periods, our banks stopped 
paying in gold. It is our duty to give to the world an over- 
whelming evidence of our ability and determination in the 
future to maintain our gold obligations under any and all 
circumstances. 

(6) "The vast accumulation of gold in the hands of the 
Federal Reserve banks which I am urging is of great mo- 
ment in its bearing upon the future of the National bank 
currency. The objects contemplated in this respect by the 
Federal Reserve Act are highly to be commended; but 
carrying this scheme into effect is subject to too many de- 
lays. More comprehensive action from the beginning would 



286 LOANS AND INVESTMENTS 

have brought about better results. The ultimate aim which 
we must have in mind is the conversion of a large portion of 
the two per cent, government bonds now securing circula- 
tion into new three per cent, bonds, a substantial portion of 
which will gradually be absorbed by the people. This would 
have the consequence of reducing the amount of National 
bank circulation, so that, at a given point, whatever two per 
cent, bonds the Federal Reserve banks acquired would ulti- 
mately be carried by Federal Reserve note circulation, and 
this, in turn, would be of material assistance to the Federal 
Reserve banks in earning their dividends. As the absorption 
of the three per cent, bonds by the public proceeded, and as 
the growing acceptance market offered a wider field of in- 
vestment for the Federal Reserve banks, Federal Reserve 
notes would take the place of Federal Reserve bank notes, 
bankers' acceptances and commercial paper would take the 
place of government bonds and an elastic and live currency 
would replace the present inelastic government bond se- 
cured currency. In order to carry out this process, however, 
it will be necessary normally to maintain against Federal 
Reserve notes at least the forty per cent, reserve required 
by law, as against the five per cent, of reserves now required 
against National bank notes. And this, again, is an added 
reason for facilitating the concentration of gold in the Fed- 
eral Reserve banks, so that they may be strong enough to 
sustain this large volume of circulation on the higher reserve 
basis. The larger powers which we should enjoy would not, 
therefore, be employed to inflate circulation. On the con- 
trary, as a net result, it would be used for the purpose of 
building up a circulation covered by a far stronger gold 
reserve than that of the National bank notes. Until the 
volume of the latter has been materially reduced, and until 
Federal Reserve notes may be accepted as reserve money by 
the member banks, the lending power of the Federal Reserve 
banks will remain hampered. 



LOANS AND INVESTMENTS 287 

(7) "The Federal Reserve banks have made investments 
aggregating at present about $180,000,000 and have out- 
standing a net circulation of about $16,000,000. That means 
that for $164,000,000 of investments they have paid gold and 
thereby have reduced their reserve power to that extent. If 
they could have paid in Federal Reserve notes instead of 
gold, as they should have been permitted to do, they would 
have wasted only forty per cent, of this amount and would 
have retained the balance, that is, about one hundred mil- 
lions, as a potential reserve for additional note issue. As 
stated before, it does not necessarily follow that Federal 
Reserve banks would have made larger investments at this 
time; it is not at all likely that they would have done so. 
But emphasis must be laid upon the resulting reductions of 
their power to assist the country in an emergency. The 
argument is used that if Federal Reserve notes had been 
paid out and could have been counted as reserve money by 
the stock banks, these notes would have gone into the vaults 
of the member banks as reserve money and caused a further 
expansion of loans. But we must not forget that the same 
result has followed by the Federal Reserve banks paying out 
gold. As far as the member banks are concerned, the effect 
is the same whether they receive $164,000,000 in gold or in 
Federal Reserve notes which may be counted as gold. But 
the difference is, as we have stated, that under the present 
system the lending power of the Federal Reserve System is 
being impaired too fast. Federal Reserve notes 'shall be 
obligations of the United States and shall be receivable by 
all National and member banks and the Federal Reserve 
banks and for all taxes, customs and public dues. They shall 
be redeemed in gold at the Treasury/ etc. Did we not stop 
half-way when we provided that banks are thus to receive 
Federal Reserve notes in payment of debts among each 
other, and from their depositors, but cannot count them as 
reserve for the purpose of discharging their deposit liabil- 



288 LOANS AND INVESTMENTS 

ities ? As a consequence, banks when settling with each other 
through clearing do not accept Federal Reserve notes, but 
must settle with lawful reserve money — that is, substantially 
in gold. If, however, a bank settled directly with another 
bank it could pay in Federal Reserve notes and the payee 
bank could then send the Federal Reserve notes to its Fed- 
eral Reserve bank, create a balance and then count that as 
reserve. It is fortunate that the new amendment will permit 
member banks to carry any part of their required vault 
reserve as a balance with the Federal Reserve bank and to 
count it as reserve. It is hoped that this will cause member 
banks promptly to adopt the habit of settling their balances 
with each other by transfer of credit through their Federal 
Reserve banks, thereby releasing gold needlessly tied up in 
clearing operations and in their vaults and remedying, to a 
certain extent at least, these anomalous conditions. 

(8) "In dealing with this question of reserves and note 
issue, it is proper and necessary that we proceed step by 
step. Splendid progress has been made in these last two 
years and we realize, of course, that the tracks must be 
shifted many a time before we can reach our final goal. But 
we must be clear about this ultimate aim and we must recog- 
nize the absolute necessity of taking certain consecutive 
steps before monetary and banking reform will be complete. 
Ultimately we must rid our country of the confusing multi- 
plicity of currency with which we are now afflicted, and the 
Treasury will have to stop issuing small denomination gold 
certificates. The circulating currency of the country ought 
to be silver certificates in the small denominations, and 
Federal Reserve notes. The best place for gold and gold 
certificates will be in the Federal Reserve banks. The 
National bank currency ought to be systematically with- 
drawn, and the greenbacks ought to be gradually turned 
into gold certificates as the missing gold cover from time to 
time is produced by the excess profits to be received from 



LOANS AND INVESTMENTS 289 

the Federal Reserve banks or by some more rapid process 
that the future may evolve. While this process is taking its 
course I think we are fully justified in permitting the Fed- 
eral Reserve banks to count greenbacks as part of their 
metallic reserve. It is freely admitted that this is not abso- 
lutely good banking theory. But with the $153,000,000 gold 
behind these notes and the power given to the United States 
to provide the additional gold cover by a sale of govern- 
ment bonds, we may be warranted in temporizing and not 
making an over-rigid discrimination. 

(9) "One cannot deal with the future of our Federal 
Reserve System and our reserve problem without being 
puzzled by the question, what will be the coming standard 
of differentiation between central reserve cities, reserve 
cities and country bank places when, after November 16, 
1917, balances with correspondent banks will no longer 
count as reserve. I cannot undertake to discuss that prob- 
lem today, but I think it is timely to point to this phase and 
invite you to give it your most careful consideration. The 
time is not distant when we shall have to deal with this 
conundrum and we shall welcome — indeed, we shall need — 
your very best thoughts in the matter. The Federal Reserve 
System is the beginning of an imposing structure to be 
erected upon a broad foundation. It will prove a costly edi- 
fice unless it is developed to its full growth along these 
broad lines. Member banks and the country at large have a 
very vital and obvious interest in this, and they may well 
insist that there be no stopping half-way or haphazard addi- 
tions or little patchwork here and there. The banks and 
country are now entitled to enjoy, and will soon require, 
the strongest possible system, and the further it progresses, 
the more the concentration of gold in the Federal Reserve 
banks proceeds, the further the discount market develops 
and the further grows the habit of banks, large and small, 
to invest in bankers' and trade acceptances, the less will it 



290 LOANS AND INVESTMENTS 

be necessary for them to keep unduly large sums locked up 
in their vaults and the easier will it be for Federal Reserve 
banks to return a portion of their paid-in capital. The roads 
to reduced reserve and capital requirements lie in these di- 
rections. If member banks are to rely for their protection 
primarily upon their ability to create balances with their 
Federal Reserve banks they must be certain that they have 
in their possession an easy means of approach, a reliable 
key that will open for them the floor leading to the Federal 
Reserve banks' vaults." 



EXERCISES 



Questions to be Answered by Students 

(Chapter I — Commercial Loans) 

1. Define "liquid assets" and explain why the 
assets of a commercial bank should be liquid. 

2. What are "lines of credit" and why is it 
difficult to curtail lines of credit in times of financial 
stringency? 

3. Discuss ways and means by which a com- 
mercial bank may replenish its reserves. 

4. Describe the ultimate effect of the general 
contraction of loans. 

5. How does the Federal Reserve System bene- 
fit commercial banks in maintenance of liquid assets 
and adjustment of reserves. 

6. Define "current assets" and give one or more 
examples. 

7. Define and exemplify "current liabilities." 

8. What information should bank credit depart- 
ments have, and how may such information be best 
obtained? 

9. In extending credit, what circumstances and 
conditions should be considered beyond ordinary 
statements of assets and liabilities? 

10. Discuss the ratio of collections to maturities. 

11. What are the advantages of "trade accep- 
tances" as compared with single name commercial 
paper? 

291 



292. LOANS AND INVESTMENTS 

12. What are the advantages of "single name 
commercial paper" as compared with trade accep- 
tances? 

13. Define "bank acceptances" and explain their 
utility. 

14. In your judgment what portion of a com- 
mercial bank's available funds should be invested 
in (1) marketable securities, (2) commercial paper 
purchased in the open market, (3) loans to cus- 
tomers? 

(Chapter II — Agricultural Loans) 

15. Define "commodity paper" and give ex- 
amples of instruments thus termed. 

16. In what way does the Federal Reserve 
System favor agricultural loans? 

17. Name the principal grain growing States. 

18. Explain (1) prevailing methods of market- 
ing grain, (2) process of distributing it, (3) manner 
of storage. 

19. Describe the security generally required by 
banks in making grain loans. 

20. Do banks generally give grain dealers open 
lines of credit, and if so, why? 

21. Name the cotton growing States, and state 
the amount of cotton produced in the United States. 

22. Describe the manner in which banks make 
loans to cotton planters. 

23. How do banks make advances to cotton 
buyers, and on what security? 



LOANS AND INVESTMENTS 293 

24. Define "cotton futures" and discuss trans- 
actions in connection with them. 

25. Discuss the advantages and disadvantages 
of "cattle loans." 

26. Define "cattle loan companies" and explain 
their operations. 

27. What kind of business statements should 
be required from farmers? 

28. In making loans to farmers, what are the 
principal circumstances to be considered? 

(Chapter III — Stocks and Bonds) 

29. What is the fundamental difference between 
"stocks" and "bonds?" 

30. Distinguish between "common" and "pre- 
ferred" stocks. 

31. What may be said in favor of the issuance 
of shares of stock without par value? 

32. Describe the requirements in connection 
with the transfer of stocks. 

33. Specify some of the conditions that deter- 
mine the titles under which bonds are classified. 

34. Define "coupon bonds," "registered bonds," 
and "registered coupon bonds." 

35. What particular facts and circumstances 
should be considered in buying municipal bonds? 

36. What is the usual procedure in the issuance 
and marketing of bonds? 

37. Define in your own language the financial 
terms "bull" and "bear." 



294 LOANS AND INVESTMENTS 

38. Explain the meaning of the terms "short" 
and "long" as applied to stock market transactions. 

39. Describe "watered stock" and specify two 
issues that in your judgment may be so classified. 

40. Discuss stocks and bonds as investments. 

41. Specify bonds suitable for investment by a 
commercial bank. 

42. What classes of bonds are suitable for sav- 
ings banks or trust funds? 

(Chapter IV — Collateral Loans) 

43. Distinguish between "pledge," "lien" and 
"chattel mortgage," and show which gives the 
greatest rights. 

44. May a National bank hold in pledge as col- 
lateral security for a loan made, or to be made, 
shares in the stock of another National bank? 

45. Can a National bank make a valid loan on 
the security of its own stock? 

46. What are the essentials of a valid delivery? 

47. What is "constructive delivery" and is it 
sufficient to constitute a pledge? 

48. Explain the manner in which a broker may 
hypothecate his customers' securities. 

49. When goods in a warehouse on which a 
warehouse receipt has been issued are attached by 
order of a court, what are the rights of a bank hold- 
ing the receipt as collateral? 

50. In what respect does a warehouse receipt 
differ from a bill of exchange as to negotiability? 



LOANS AND INVESTMENTS 295 

51. Distinguish between warranties and liens. 

52. Of what importance is a bill of lading at- 
tached to a draft in payment of goods for export? 

53. How does a bill of lading differ from an 
ordinary receipt? 

54. If a bill of lading held by a bank as col- 
lateral for a loan turns out to have been forged by 
one of the carrier's representatives, who is re- 
sponsible, and why? 

55. What is the difference between a "Straight" 
bill of lading and an "Order" bill of lading? 

56. Explain why a bank should not surrender 
a bill of lading attached to a draft without accep- 
tance or payment of the draft. 

(Chapter V — Seasonal Demands for Money) 

57. Describe seasonal variations in demands 
for money in New York City. 

58. What are the seasonal variations in demands 
for money in your own locality? 

59. Explain how seasonal variations in demands 
for money influence prices of bonds. 

60. How do seasonal demands for money affect 
bank reserves? 

61. Define "secondary reserves" and explain 
their utility. 

62. What are the three essential characteristics 
of secondary reserves? 

63. What is meant by "emergency market- 
ability?" 



296 LOANS AND INVESTMENTS 

64. Discuss the relative merits of bonds and 
commercial paper as secondary reserves. 

65. Specify a few issues of bonds that would in 
your judgment be suitable for secondary reserves. 

66. How does commercial paper serve the pur- 
pose of secondary reserve in Europe? 

67. Why has commercial paper in the United 
States been largely local in character? 

68. How may a commercial paper market be 
developed in the United States? 

69. In what manner will the Federal Reserve 
System tend to change the character of secondary 
reserves? 

70. Define "business cycles" and discuss their 
cause and effect. 

(Chapter VI — International Exchange) 

71. Define "foreign exchange" and explain the 
difference between foreign and domestic exchange. 

72. What is the "mint par of exchange" and how 
is it computed? 

73. What is the "gold import point" and under 
what circumstances is gold imported from foreign 
countries to the United States? 

74. What is the "gold export point" and under 
what circumstances is gold exported from the 
United States to foreign countries? 

75. What factors determine the price of gold in 
international exchange? 

76. What are "cable transfers" and why is the 



LOANS AND INVESTMENTS 297 

cable transfer rate of exchange higher than the de- 
mand rate of exchange? 

77. Name and describe the different kinds of 
time bills of exchange. 

78. Define "arbitrage" and illustrate an arbi- 
trage transaction. 

79. What are "finance bills" and how are they 
handled? 

80. Describe the three forms of "revolving 
credit." 

81. Describe the methods of financing imports 
and exports. 

82. How is the demand rate of exchange deter- 
mined? 

83. Explain the relation of interest rates to for- 
eign exchange rates. 

84. Define "dollar exchange" and discuss its de- 
velopment. 

(Chapter VII — Bonds and Circulating Notes) 

85. Explain the difference between the liability 
of a bank in issuing bank notes and the liability of 
a bank receiving deposits. 

86. Why do bank notes remain outstanding 
longer than bank checks? 

87. What are the principal methods of protect- 
ing bank notes? 

88. Explain the Canadian "guaranty fund" for 
the protection of bank notes and describe its oper- 
ation. 



298 LOANS AND INVESTMENTS 

89. How has bond-secured currency under the 
National Bank Act proved unsatisfactory? 

90. Specify the different forms of currency in 
the United States. 

91. What are "greenbacks" and how are they 
secured. 

92. Define "inelasticity of currency" and explain 
its effects. 

93. Discuss the difference between protection 
accorded to bank nptes and to bank deposits. 

94. What forms of notes are issued under the 
Federal Reserve Act? 

95. Explain "Federal Reserve Notes." 

96. What are "Federal Reserve Bank Notes" 
and under what conditions are they issued? 

97. Explain the provisions of the Federal Re- 
serve Act for the conversion of two per cent, bonds. 

98. Discuss the relationship between Federal 
Reserve notes and bank reserves. 

99. Explain the procedure of Federal Reserve 
banks in taking over the bonds held by National 
banks as security for circulation. 

100. Why should gold be concentrated in the 
Federal Reserve Banks? 

INSTRUCTIONS.— In City Chapter Classes the 
foregoing questions are to be used in connection 
with the respective subjects to which they pertain. 
Correspondence Chapter students will submit an- 
swers to all of the one hundred prescribed questions 
at the same time. 



INDEX 

Numbered Paragraphs 

Adequacy of Reserves 169 

Adjustment of Reserves 13 

Advantages of Single Name Paper 39 

Advantages of Trade Acceptances 38 

Agricultural Paper for Rediscount 82 

Aldrich-Vreeland Act 17 

Altered Bills 150 

Arbitrage 198 

Arrival Rates 212 

Assets Must Be Liquid 5 

Assistance of Federal Reserve Banks 62 

Attachment of Goods Under Bills of Lading. . 153 

Bank Acceptances 41 

Bank Advances to Cotton Buyers 59 

Bank Balances and Bonds 10 

Bank Notes and Checks 224 

Bank Notes and Deposits 222 

Banks and Stock Exchanges 119 

Bills of Lading 146 

Bond Issuance Ill 

Bond Selling Syndicates 114 

Bond Underwriting Syndicates 113 

Bonds and Bank Notes 229 

Bonds and Their Classification 97 

Bonds as Investments 120 

Bonds as Secondary Reserves 180 

299 



300 LOANS AND INVESTMENTS 

Borrowing and Lending Exchange Markets. . 211 

Business Cycles , 182 

Buying Cattle Loans 79 

Cable Transfers 194 

Cash and Credit 4 

Certificates of Stock 91 

Classes of Notes 234 

Classification of Time Bills 196 

Collateral Loan Agreements 159 

Collateral Notes 158 

Commercial Paper in Europe 175 

Commodity Paper 42 

Common Carriers 145 

Cotton and Its Production 52 

Cotton Exchanges 66 

Cotton Merchants and Exporters 63 

Credit Analysis and Single Name Paper 34 

Currency and Bank Reserves 246 

Current Assets 24 

Current Liabilities 25 

Danger from Borrowing in Both Ways 40 

Demand for Notes 236 

Demand Rates of Exchange 185 

Development of Dollar Exchange 219 

Documentary Acceptance Bills 197 

Domestic Exchange 184 

Drainage and Reclamation Bonds 109 

Equipment Bonds 107 

European Financing of Am. Foreign Trade . . 202 

European War and the Exchanges 214 



LOANS AND INVESTMENTS 301 

Export and Import Points 191 

False Bills . 148 

Farmers' Statements 80 

Federal Reserve Act 18 

Federal Reserve Bank Notes 238 

Federal Reserve Notes and Bank Reserves . . 242 

Finance Bills 199 

Financial Terms 118 

Financing Exports of Cotton 65 

Financing of Exports 204 

Financing of Imports 203 

Foreign Exchange 183 

Foreign Exchange Departments 205 

French Exchange 188 

General Contraction of Loans 14 

General Loan Contraction to Be Avoided. . . 16 

German Exchange 189 

Goods Lost or Damaged in Transit 152 

Goods Not Owned by Shipper 151 

Grain Crops 43 

Grain Elevators and Warehouses 44 

Grain Exchanges 47 

Grain Loans 48 

How Demand Rate of Exchange is Determined 206 

Industrial Bonds 106 

Inelasticity of Currency . . . 231 

International Borrowing 207 

Lack of Commercial Paper Market 179 

Land Mortgage Bonds 110 

Legal Tender and Other Reserve Credits. ... 170 



302 LOANS AND INVESTMENTS 

Limited Significance of Balance Sheets 32 

Lines of Credit 6 

Liquidation of Assets 29 

Liquidness of Loans to Depositors 7 

Live Stock Loans 69 

Loans and Deposits 3 

Loans by Foreign Banks 208 

Loans on Cotton in Warehouses 61 

Managers' Shares 94 

Marketing Cotton 57 

Marketing Grain 45 

Mint Par of Exchange 186 

Municipal Bonds 103 

National Foreign Trade Policy 221 

Negotiable Warehouse Receipts 138 

Negotiation of Order Bills 147 

Non-Liability of Pledgee as Warrantor 154 

Non-Negotiable Warehouse Receipts 137 

Notes as Needed 237 

Notes Based Upon Business Transactions . . . 243 

Notes Under the Federal Reserve Act 233 

Panic Demands for Currency 240 

Policy of Note Issue 241 

Position of London 213 

Problems of Conversion (of Government 

Bonds) 245 

Procedure in Issuing Bonds 112 

Process of Conversion 235 

Protection of Notes 225 

Public Utility Bonds 105 



LOANS AND INVESTMENTS 303 

Quarantine Line 73 

Railroad Bonds 104 

Rates on Time Bills 195 

Ratio of Collections to Maturities 33 

Ratio of Current Assets to Liabilities 28 

Rediscounts 9 

Relation of Interest Rates to Exchange Rates 209 

Relation of Notes to Currency 223 

Reserve Banks and Commercial Loans 20 

Reserve Banks and Liquidness 19 

Revolving Credit 200 

Rights and Liabilities of Pledgor 128 

Sales Made by Grain Buyers 49 

Seasonal Movements in Money Markets 160 

Seasonal Strains on Bank Reserves 168 

Seasonal Variations in Foreign Exchange . . 166 

Seasonal Variations in Prices of Bonds 167 

Secondary Reserves and Their Character . . 171 
Secondary Reserves Under Federal Reserve 

System 181 

Security for Bank Notes 228 

Shares Without Par Value 93 

Shipper's Loan and Count 155 

Significance of Changes in Exchange 

Quotations 190 

Situation in the United States 178 

Sources of Payment of Bank Loans 21 

Spent Bills 149 

Statements of Borrowers 27 

Status of American Note Currency 230 



304 LOANS AND INVESTMENTS 

Sterling Exchange 187 

Stock Exchanges 115 

Stocks and Their Classification 86 

Surrender of Bills of Lading to Drawees. ... 157 

Taking Over Government Bonds 244 

Theory of Note Issue 227 

The War and the London Acceptance 215 

The War and the London Discount Market 216 

The War and the London Sight Rate 218 

The War and the New York Exchange 

Market 217 

Timber Bonds 108 

Time Factor in Gold Shipments 193 

Time of Retirement (of Government Bonds) . 239 

Trade and Single Name Paper Compared ... 36 

Trade Paper 35 

Transfer of Stocks 95 

Travelers' Letters of Credit 201 

Ultimate Effects of Contraction 15 

United States Cotton Futures Act 68 

Utility of Bankers' Time Bills 210 

Variable Prices of Gold 192 

Volume of Sales 31 

Voting Trust Certificates 92 

Warehousemen and Warehouse Receipts 135 

Warehousemen's Liens 143 

Warranties of Genuineness 141 

What May be Pledged 125 

Why Notes Are Issued 226 

Word "Notify" on Order Bills 156 




,0* .-^!. *o. 




















iPv\ 




,H«fe 




«bl 



^ 



WERT W* „A V *V J ^il^ a <£^ "°WWxW* A V ^ 

BOOKBINDING g V^3Gr»* <,V 

MIO0CET0W*, PA « A Jk ♦ *y"^, -,\- 

MAR 84 1 A 

QntKyBounc ■ 4 ^* fe O - « # %£ ^V . W » « „ *^ A> * „ <^ 




